[OUTLOOK]North’s reforms reverberate

An underappreciated aspect of the North Korean economic reforms launched in July 2002 is the implications for internal political stability. Unlike the diplomatic maneuvering of the past several years, which has had little immediate impact on most North Koreans, economic reforms have directly affected them, raising the specter of internal instability with enormous political and economic implications for South Korea.
The reforms are contributing to growing social differentiation and inequality, creating what United Nations officials have described as a new class of urban poor. At the same time, the policy changes have necessitated a reinterpretation of the North Korean doctrine of juche, or self-reliance, to legitimate the reforms and justify the departure from the country’s socialist tradition. Today’s North Korean regime embodies elements of both communism and Confucian dynasty, is sovereign with respect to only part of the divided Korean nation, and is vulnerable to pressure from external powers. Under these conditions, change at the grassroots level and ideological reorientation yield an unusually broad set of possible transition paths and successor regimes, ranging from maintenance of the status quo to evolution to revolutionary upheaval, the latter in all likelihood implying the North’s collapse and its absorption into the rival Southern state. Given the lack of clear lines of succession in the North, even something as prosaic as the sudden death of Kim Jong-il could set in motion profound political changes on the Korean peninsula.
Statistical models developed for my new study Korea after Kim Jong-il indicate that economic performance critically influences regime stability and that the North’s external relations play a crucial role. At present, there is about a 5 percent chance of regime change in any given year, down from its peak in the 1990s. Under a scenario of “cooperative engagement” in which improvements in North Korea’s external relations reinforce its economic reforms, the likelihood of regime change declines. However, as detailed in the book, a worsening of diplomatic relations and economic interaction would greatly increase the probability of regime change in North Korea.
A collapse and absorption scenario would have profound economic and political ramifications for the South (and of course be accompanied by an enormous reduction in poverty in the North). Over the course of a decade, the “costs” of unification to South Korea might be on the order of $600 billion. Although remaining positive, economic growth in the South would slow relative to a no-unification baseline, and unless compensatory policies were undertaken, the process of economic integration with the North would likely lead to an increase in income and wealth inequality.
Yet even less apocalyptic gradual integration scenarios pose significant challenges for South Korea as well. South Korea has considerable problems with opaque and corrupt government-business relations. In the North, there is no real difference between the state and the economy. Any large-scale economic integration between the North and the South will be by its very nature a highly politicized process and will in all likelihood retard progress in cleaning up business-government relations in the South. Recent corruption scandals involving the Blue House and the Korean Development Bank with respect to Hyundai Asan’s activities in the North are emblematic.
Regardless of its economic progress or policy stance, South Korea remains exposed to the vagaries of North Korean behavior. South Korea’s growing integration with the rest of the world creates new vulnerabilities in this regard. Financially, South Korea is increasingly integrated into the world economy. The use by South Korean financial firms of off-balance sheet transactions and financial derivatives, which did not exist in 1994, has expanded greatly. While it is true that the South Korean stock market actually rose during that earlier crisis, the expanded role of foreign participants and the increased complexity of the financial transactions mean that the market today is far less susceptible to political intervention than it was a decade ago.
The popular image of capital flight occurring when foreigners run for the exits is belied by historical experience the world over ― almost invariably it is the better-informed locals who are out the door first. During periods of uncertainty, Bank of Korea data reveal that while foreigners were net buyers in the stock market, South Koreans were net sellers.
Under such circumstances, South Korea should commit to the principle that North-South engagement should be done on efficient, transparent terms, adopting a tax-based approach. In addition, while engaging, South Korea should prepare for the possibility of collapse in the North, by strengthening its economy, improving its internal mechanisms of resource mobilization, allocation, and management, and accumulating fiscal reserves.

* The writer is a senior fellow at the Institute for International Economics in Washington D.C.

by Marcus Noland