KOREA FOCUS
Korean Reunification: Costs, Gains and Taxes
Shin Chang-min

Honorary Professor
Chung-Ang University


I. Introduction
 
When President Lee Myung-bak recently made a brief comment about a prospective unification tax, many of the South Korean people seemed to be at a loss, worrying about what they imagined would be a huge new burden. However, on closer examination, they will eventually learn that this should not be a serious concern.
 
First, the timing of the tax proposal by President Lee was quite appropriate.The presidential initiative was rather belated because taxation is a concept that is perfectly natural in the course of preparing for national reunification. When the prospective costs of and gains from reunification are considered, the benefits of taxation become apparent.
 
As a result of calculating the approximate scale of necessary costs, deliberating on the possible methods of raising the money, and considering the eventual benefits of unification, the author has reached the conclusion that the nation can meet the cost of accomplishing reunification on its own; the sooner reunification occurs, the lower the necessary costs will be; and the South alone will enjoy tremendous benefits from reunification, including 11.25 percent annual economic growth during the first decade following territorial unification. In narrowing the income gap between the two parts of the peninsula, North Korean residents would experience drastic changes in their living standard as if they have moved to heaven from hell.
 
Therefore, when the chance appears for reunification with the economically impoverished North, there is no reason for the South to fear or reject the opportunity. In view of the series of recent events surrounding the divided peninsula, the time has come for the South to accelerate efforts to advance unification. In this regard, a unification tax may be devised as follows: 
 
a) The unification cost estimated in this research turns out to be about 7 percent of the nation’s GDP annually for 10 years after reunification. Of this amount, 1 percentage point can be met by collecting additional tax revenue and 3 percent by issuing state bonds.
 
b) It is desirable to exert utmost efforts to advance unification through the method of economic cooperation between the North and the South. A potentially optimal amount to spend for that purpose could be about 1 percent of the South’s GDP annually until the time of territorial reunification on the peninsula. It is suggested that one-fourth of this 1 percent be met through taxation and the rest by issuing state bonds.
 
c) It is suggested that the unification tax be named the “North-South (or alternatively South-North) Economic Cooperation Fund” before unification and the “Regional Development Fund” after unification.
 
II. The Scale of Unification Costs and Economic Benefits from Unification
 
1. The Scale of Costs
 
Provided that unification costs are defined as all expenses or investments required for managing a unified Korea, they will include:
 
a) Expenditures for coping with emergency situations resulting from reunification;
 
b) Expenditures for achieving systemic unity of the two halves of Korea in all areas; and
 
c) Investments needed to secure the production infrastructure and various physical capital needed to raise the income level in the northern half of the unified peninsula up to one-half of the income level of the South.
 
What needs to be noted here is that the investments of the third category are for development of the backward economy in the northern half, which will lead to the accumulation of physical capital and national wealth of a unified Korea. Accurately speaking, this is investment, not cost, in terms of economics. However, this investment is compulsory, not the object of choice on the basis of cost-benefit analysis. 
 
2. Economic Benefits from Reunification
 
A successful reunification of the divided peninsula will result in numerous benefits. Most of all, the majority of former North Korean residents will experience a tremendous rise in their living standards as well as increased freedom and human rights. As for South Koreans, who will practically lead the unification procedures, their benefits will include:
 
a) Gains from no longer paying for costs incurred by territorial division;
 
b) Enormous and unprecedented economic gain from participating in economic construction and physical capital accumulation in the northern half, which will be financed with the ”Regional Development Fund” that will be raised in many ways including a “Buy Korean Products Policy”; and
 
c) Very diverse advantages and conveniences from the synergy between the complementary industrial input from the two sides, positive externalities to cut production costs, economies of scale from the enlarged domestic market, and subsequent increases in income and expansion of amenities.
 
These benefits will all continue to accrue over the long term, as income in the northern half is raised to half the level of the south and then economic unity is achieved to build a greater Korean economic sphere.
 
III. Estimation of Unification Costs and Its Indications
 
1. The Method of Estimation
 
Since a 10-year period is an appropriate time frame to consider in readjusting the income levels between the northern and southern halves of a unified Korea, the table below shows the estimates of unification costs necessary at different points in time.
 
 
2. Indication of Estimates
 
First, the nation’s economic capabilities will be sufficient for handling the estimated costs of unification. Second, the earlier the time frame is, the lower the cost estimate becomes both in percentage terms and in absolute amount compared to South Korean GDP. In addition, immense economic benefits can be attained if enough funds are accumulated to meet the unification costs. For example, if the South Korean government fully prepares to implement a “Buy Korean” policy on an extensive scale during the income readjustment period, the unified Korea can be expected to raise its GDP by up to 11.25 percent per annum throughout the 10-year period. Hence, all other factors aside, the economic gains alone justify all-out efforts by the South to achieve reunification at the earliest possible date.
IV. Policy Recommendations to Minimize Unification Costs
 
Korea should avoid Germany’s experience of huge costs and waste following sudden unity without adequate preparations. Through meticulous preparation, we should minimize confusion and costs while maximizing benefits, thereby achieving a successful unification.
 
The media raises public concerns by simply presenting cost estimates without explaining the background of the calculations. The mammoth figures only cause alarm and instigate a widespread sense of antipathy toward reunification itself. In actuality, the cost of reunification will vary depending on the assumptions about the processes and circumstances in which Korea is unified. In most estimates, however, exorbitant amounts are regarded as pure expenditures from government coffers, just like welfare spending for the needy.
 
As the table above shows, unification costs around 7 percent of GDP in any time frame. In broad calculations, 2 percentage points can be covered through reducing military expenditures with the help of world powers during the 10-year income readjustment period. One percent can be met with long-term, low-interest loans from international financial institutions and the remaining 4 percent by state bonds (3 percent) and unification tax (1 percent).
 
In 1991, US$100 billion was the estimate for unification costs by the Korea Development Institute.  However, that amount, equivalent to $143 billion in 2009 dollars, was actually the cost of addressing emergency situations following reunification and streamlining the differing systems in all fields and areas, and would roughly account for one-tenth of the total unification costs calculated in this research.
 
To prepare the money, the government may shift part of its less urgent appropriations to these purposes. The “reconciliation contributions” accompanying the possible “Buy Korean” policy, which will be explained later, may also be used. When the northern residents’ income rises beyond minimum living costs, some income taxes can be collected from them. To meet immediate needs, short-term overseas loans may be drawn separately from the aforementioned long-term credits. The government may also use its rice reserves during emergencies.
 
In general, the key to a successful financial policy for the initial 10-year settlement period lies in: 1) the separate economic management of the two parts of the unified peninsula, 2) reduction in military expenditures, 3) the “Buy Korean” policy, and 4) maintenance of the state ownership of real properties in the northern territory.
 
1. Separate Economic Management of the North
 
Ten years are necessary to reduce the income gap between the North and the South to a sufficient extent and then unify their economies. While political, administrative, military, educational, social, and all other systems would have to be integrated immediately after territorial unification, economic unification would have to wait until the northern residents’ income level reaches about half that of the southerners. The 10-year transition is needed to help those in the North learn how to catch fish rather than receiving fish to eat day after day from the South. It is beyond the South’s capabilities to dole out living expenses for North Koreans as the Germans did.
 
Some may raise doubts as to whether separate management of the economies of the two parts could be possible. We can consider both the “pulling effect” and “pushing effect” of keeping the northern residents in their old communities after reunification. If their economy improves and jobs are created in their own places, why should they desert them and roam about in strange towns? And if incentives in the form of daily necessities and living subsidies are given only to people who stay in their old places, they will not risk moving to the South. And in fact those people in the North actually have been living under government control in places not necessarily of their own choice for more than half a century.
 
2. Buy Korean Policy
 
A “Buy Korean” policy is recommended as a vital step to maximize the benefits of unification and to help cover the unification costs. As a long-term strategy, Seoul should try to convince the governments of neighboring countries and world powers about the need for the policy well in advance. It would be too late if unification comes before mutual understanding is established with concerned nations.
 
In providing physical capital needed for economic growth in the northern territory, the government should seek to supply at least 80 percent of materials from the South. This will increase the GDP in the South by some 5.6 percent every year. And production will be increased through the shift of military manpower to industry in the South. When the trend growth rate in the South is added, the annual growth rate will amount to 11.25 percent during the 10-year settlement period. This will bring about a second take-off of the Korean economy, reminiscent of the boom in the 1970s achieved under the government of President Park Chung-hee.
 
The increased demand under the special economic circumstances following unification will boost profits for a number of businesses. It will thus be justifiable to collect extra contributions from these firms and use them to meet the costs for systemic integration and address problems arising from the process of reunification.
 
3. Reduction in Military Expenditures
 
Military expenditures during the economic adjustment period after reunification should be limited within 1 percent of GDP. The reduction in military expenses will certainly help conserve resources for paying unification costs. Hence more physical capital can be produced in the South for the economic growth of the North. Cooperation of surrounding powers is again necessary to save Korea from involvement in any international disputes that may require the nation to increase its military spending. After World War II, Japan was able to keep the operating budget of the Self-Defense Forces at 1 percent of its GDP under U.S. protection. Likewise, Korea needs international security guarantees from the United States, Japan, China and Russia to be able to maintain the 1 percent limit in its military spending for at least the 10-year period after reunification.
 
A military drawdown may invite dissatisfaction among professional soldiers in the South. But they would be guaranteed their jobs even after reunification. Conscripts might be recruited chiefly from the northern youths, who would still be less skilled as industrial manpower. Young South Korean men who will be released from compulsory service may attend college or work for industrial firms to increase their present and future productivity. Officers and the cadre personnel in the former North Korean People’s Army should all be retired and put into industrial training. It is desirable that the U.S. Forces Korea remain on the peninsula through the 10-year transition and for a considerable period thereafter.
 
4. Overseas Loans
 
Plans to secure financial resources to meet the reunification costs should include drawing long-term, low-interest loans from the World Bank or other international lenders on the grounds that North Korea was one of the poorest countries in the world. Unified Korea can ask for favorable terms for the loans with its own strong economic potential based on the economic capability of the southern half.
 
5. State Bonds and Taxes
 
As stated above, taxes amounting to 1 percent of GDP may be collected to cover the unification costs for the 10-year transition period and bonds equivalent to 3 percent of GDP may be issued. The bond issue is significant because it divides the unification costs between generations, who will all enjoy the advantages of a unified Korea.
 
It is not desirable to collect a unification tax far ahead of unification. The tax should be levied as needed to avoid any unnecessary constriction of the national economy. Likewise, it would be better to avoid the issuance of unification bonds far in advance. From a different perspective, if the government is to raise funds totaling 1 percent of GDP through taxes (possibly 0.25% of GDP) and government bonds (the remaining 0.75%), it will be tremendously useful for economic cooperation to build up infrastructure in the North even before political unification.
 

Similar to the “solidarity surcharge” in Germany, the unification tax may be collected in the form of a surtax on individual income and corporate profits. Conversion of the current defense tax into a unification tax by a simple name change is unacceptable because it is a legacy of the era of confrontation. Neither is collecting the new tax in the form of the universal value added tax desirable because it will place a greater burden on the economically underprivileged. Some suggest creating an “inter-Korean cooperation fund” that depends on donations, but private donations would have limited effects.

V. Other Important Policies
 
There are several more notable policies to recommend.
 
First, emergency plans should be established to prepare for sudden developments following reunification and they should be constantly updated.
 
Second, property in the northern territory should not be privatized and a new concept of “public ownership and private use” would be needed.
 
Third, real estate that residents of the South and the North had owned in the other side prior to the national division should not be returned to the claimed owners even if they have documentary evidence of ownership. These properties could be compensated by cash through special legislation based on the 1949 land reform law enacted in the South.
 
Fourth, technology transfer from the southern to northern regions should be expedited with government support so that economic improvement can be accelerated in the northern territory.
 
Fifth, retired manpower in the South should be utilized for economic growth in the North. Payments could be much less than what they had earned but such jobs would provide them with opportunities to serve their nation. They would certainly prove to be valuable human capital that will help speed up productivity in the northern regions.
 
Sixth, North Korean currency should be converted into South Korean notes by its current real value, not by the face value as was done in Germany.
 
Seventh, wages for the northern residents during the first 10-year income readjustment period should be based on their current productivity. Instant improvement of their welfare to match southern standards would cause an unbearable burden to the government and might spoil the northern residents.
 
Eighth, special legislation to restrict collective action of labor unions in the northern territory during the 10-year settlement period will be necessary.
 
Ninth, a harmonious and balanced regional development plan should be drawn up to ensure an ideal distribution of industrial facilities throughout the peninsula. Underdeveloped regions in the North should be provided with proper means for natural conservation and connected to developed regions in the South under a comprehensive blueprint aimed at creating a truly ideal, advanced country. Simple notions of exploiting cheap labor in the North are unacceptable for many reasons.
 
 
VI. Additional Remarks
 
North Korea’s founder Kim Il-sung, who had confidently called for a “Koryo confederation system” comprising North and South Korea in the 1960s, said in his New Year address in 1990 that he rejected “unification by eating up,” that is, unification by the South absorbing the North. Twenty years later, an editorial of the North Korean party organ, Rodong Shinmun, said that the North should not bequeath a “begging and limping economy” to posterity. Still, the pitiable catchword of juche, or self-reliance, reverberates across the country as the regime fears “reform and openness” as the short path to its downfall.
 
The North’s struggle for survival under juche ideology will end up in total exhaustion anyway. A small state can neither develop nor survive in isolation. The economic gap between the two Koreas is growing irrevocably wider. The North is doomed to crumble in whatever course it may take from the present state of its economy.
 
Then, is there a consensus in the South on how to work towards reunification? We should honestly admit that we acutely lack in preparedness. The North should implode and collapse without doing any harm to the South. A stupid tug of war with the unpredictable regime in the North would only incur unbearable damage on our part. It is time for the South to end its defensive division management and bravely step onto the road to the assured destination.
 
In summary, as we arrive at the conclusion that (1) the unification cost can be affordable, (2) the sooner the time of reunification, the better, and (3) the economic gain can be huge for South Korea even during the initial settlement period of 10 years, it is strongly recommended that the South Korean people form a national consensus to make all-out efforts to attain reunification as soon as possible.
 

In order to accomplish this goal, the South Korean government needs to practice a two-track policy as the author has been consistently suggesting since 1994. Maintaining a simple and straightforward single-track strategy toward the North Korean government is not wise for the future of the nation. An additional track is necessary to attract and grasp the minds of ordinary people in the North, while avoiding unnecessary frictions with their government. It can be done through massive economic cooperation to build up infrastructure in the North, which will be useful for economic development of the northern territory after reunification.

[Unification and Law, Vol. 3, November 2010,
published by the Ministry of Justice, Republic of Korea]