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Germany’s unification lessons for Korea

by Jesper Koll

Japan and Asia stand at a key turning point. As slowly but surely North Korea prepares itself to emerge from decades of isolation, an enormous potential investment boom opportunity is poised to unfold. For an economist, North Korea and Japan are a match made in heaven — Japan offers a huge capital and savings surplus but lacks people and natural resources; so, on an economist’s drawing board, Japan has what North Korea needs, and North Korea has what Japan needs.

Of course, the real world is so much more complex than a clean drawing board. It’s outright messy. Decades of mistrust, isolation and sometimes open confrontation may make it hard to imagine a real turning point in the relations of nations. North Korea lies at the very center of Asia’s three economic superpowers, China, Japan and South Korea, and America is still both a dominant economic force and potential game-changer. So it’s complicated, and it’s about so much more than Japan. Yet without a doubt, the sooner negotiations shift from the threat of war to the potential “win-win” of economic modernization and shared prosperity, the more confident we can be that true peace has been won.

To assess the economic opportunities and challenges created by a potential modernization of North Korea’s economy, German unification in general, and the modernization of East Germany in particular, offers some useful lessons. Although the academics are still debating the exact numbers, let me get the big numbers out right in front: Basically it looks like East Germany’s modernization created approximately $2.5 to $3 trillion of private sector investment in the first decade since unification. Together with approximately $1.5 to 2 trillion of public sector support, this boosted East Germany’s per capita GDP from approximately 40 percent of West Germany’s levels to approximately 80 percent over the same first decade.

Let’s put this into perspective: West Germany’s GDP at the time of unification was approximately $1.5 trillion, so East Germany’s modernization cost the former West Germany approximately an amount equal to its GDP over the first decade; but it also triggered new private investment worth twice that amount at the same time. Almost 80 percent of the new investment occurred in the first five years as houses, roads, infrastructure, factories etc., were upgraded in a rush to profit from the “East Germany investment boom.” Importantly, small service businesses were quickly privatized to primarily East German buyers, who had received a nice boost in their purchasing power by the 1:1 exchange rate of East and West Deutschmarks. But of the large industrial assets, West German investors bought approximately 74 percent and East German investors approximately 20 percent. Only 6 percent was bought by non-Germans.

Clearly speaking, Germany unification was a German affair, both in terms of costs and opportunities. The economic modernization of the East turned out to remarkably smooth and, after only a little more than a decade, the fact that a united Germany elected a woman from the former East to head the government, suggests that political and social integration has followed.

In contrast, North Korea’s modernization is poised to follow a very different path. To start with, the population gap between West and East Germany was basically 4:1. It is 2:1 for South and North Korea. So while four West Germans could support one East German, two South Koreans would have to support one North Korean. More importantly, the income gap is even more dramatic. After all, East Germany was the star performer of the former socialist economies and, by the time of unification, East German per capita GDP was approximately 40 percent of West Germany’s level. In contrast, North Korea’s per capita GDP is estimated to be less than $1,500 (by the Bank of Korea), which would make the South more than 20 times richer.

Importantly, migration was a big issue in the case of Germany. Spurred by prospects of a 50 to 60 percent rise in incomes and living standards, more than 10 percent of former East Germans left to seek their fortunes in the West. For German leadership, there was never any question that economic modernization must go hand in hand with political and social unification. Given the more dramatic population and per capita income gaps on the Korean Peninsula, a more focused two-step process would be advisable, with urgent and immediate focus on economic modernization.

Bottom line: If it required $2.5 to $3 trillion of private investment and an addition $1.5 to $2 trillion of public investment to bring 25 million East Germans to within 80 percent of West German living standards over one decade, it is bound to take at least two or three times as much to get the 25 million North Koreans’ per capita GDP up to over $5,000 in 10 years. Of course, these are rough estimates and subject to potentially large errors — the original total estimates for German unification were around $1 trillion for the first decade, i.e., off by a factor of more than two.

But still, the benchmark total would be $5 to ¥6 trillion of private investment and $3 to 4 trillion of public support. South Korea generates GDP of about $1.5 trillion (coincidentally just about the same as West Germany did in the year before unification). That is too much for South Korea to handle alone — the investment opportunity would be almost four times South Korea’s GDP, and public support of more than two times its GDP, i.e., more than twice as much as we saw in Germany.

It is fair to say that Korea alone simply does not have the savings and capital to fund the modernization of the North. However, if we include China and Japan, which command annual GDPs of $12 trillion and $5 trillion respectively, North Korean economic modernization easily becomes feasible. One decade of new investment would come to just about 30 percent of China-Japan-Korea current combined annual GDP.

Of course, many questions must be worked out. For example: How exactly would the investment syndicates work, and governed by what laws? What role would the Asian Development Bank and Asian Infrastructure Investment Bank play? How quickly could North Korean economic planners and entrepreneurs be brought up to speed to direct state-of-the-art public-private partnership investment deals? How are projects allocated and, most importantly, who gives the go-ahead and who enforces global best-practice project governance?

The good news is that China in particular, but also Japan and South Korea, have an outstanding track record of modernizing economies in record speed. If at all, chances are that China in particular may want to use North Korea as a first Asian showcase model on how to successfully export China’s model of development and capitalism. Politically, China appears to be in sync with the North Korean regime with its new leader-for-life directive. As such, Japan’s role becomes ever more crucial to ensure that record-speed economic modernization does indeed create prosperity for all, within a global framework based on the rule of law.

Based in Tokyo, Jesper Koll is WisdomTree’s Head of Japan. Researching and investing in Japan since 1986, he’s been consistently ranked as a top Japan strategist/economist. He publishes blogs at www.wisdomtree.com/blog .