The Lessons of the German Unification Process for Korea

Chaired by Helmut Schmidt
17-18 February 1993
Paris, France

At its eighth session, held in May 1990 in Seoul, the InterAction Council adopted a Final Statement which, inter alia, contained the following proposal:

"The dramatic changes taking place in the world today demand equally dramatic and courageous decisions by the governments of South and North Korea, a nation which still remains divided. The members of the InterAction Council, concerned by this tragedy, urge the governments of the two Koreas to take the following actions as a first step toward peaceful unification:

(a) The leaders of South and North Korea should agree to meet -- without preconditions -- as soon as possible.

(b) From a humanitarian view point, both governments should permit immediate visits and unrestricted communications between members of separated families in South and North Korea.

(c) To enhance mutual confidence between the two Koreas, both governments should legalize travel by the citizens of the two Koreas to and from the South and the North. "

I. INTRODUCTION

1. With the end of the Cold War and the disappearance of East-West confrontation, new challenges demand political management in order that the emergence of new aggravations and tensions be avoided. Divided countries such as Germany and Korea were the epitome of the cold war era with its acute ideological divisions. German unification in 1989 was one of the central events of the process sealing the end of the cold war. Since then, Germany has undergone a process characterised by positive, but especially also an array of negative experiences. A series of mistakes was committed during and after the German unification process that caused avoidable pain and has had lasting consequences which may not be overcome for decades. The German experience may hold some lessons for other countries. The Korean peninsula, for one, is still mired in a conflict which reflects the harsh ideological divide, uneven economic development and the built-up of menacing military forces, including nuclear capabilities.

2. Can the Korean standoff and confrontation continue? Will the break-up of the Soviet Union, the disappearance of its Communist Party, the ensuing policies towards a market economy, the economic reforms in China and new diplomatic alignments in the region trigger Korean unification? Can such change be managed over a certain period of time or will it be abrupt, a sort of big bang, and what are the consequence of such different scenarios? In order to smoothe those difficulties and disruptions projected to arise, what are the lessons that can be learned from the German experience? The High-level Group attempted to shed light on these and numerous other issues associated with an eventual - and perceived inevitable - unification of the Republic of Korea (commonly referred to as South Korea) and the Democratic People's Republic of Korea (commonly referred to as North Korea).

II. THE ROAD TO GERMAN UNIFICATION

3. The political decision of the West German government to seize the unique opportunity for unification was both understandable and right and corresponded to the wishes of the East Germans. However, the way unification was managed calls for serious criticism. The Government had brushed aside any economic advice given by its own Council of Economic Advisers, the Bundesbank and the leading German economic research institutes, which ex post facto proved to be right on target. It can be argued that the Government should have prepared itself better by soliciting sacrifices from the population in the East and the West (e.g. through higher taxes) and preparing them to cope with hardships. The opposition, entrepreneurs and trade unions are equally to blame for their failures in that regard. Today, Germany finds itself in a recession which in the main is due to the way unification was financed. In addition, a wave of disappointment has set in as a result of the fact that the benefits of unification promised by the government have so far been absent.

4. The window of opportunity for unification appeared to be rather narrow in political terms, especially given the developments in the Soviet Union. Against this background, the last Government of the German Democratic Republic pursued a big bang approach to unification. The border to the West, including the Berlin Wall, was open and many skilled workers had left the East and moved to the West. It was impossible to check the flow of people and goods. While the command structure in the East had tangibly collapsed, the fear persisted that its hard core might seek to turn back the clock. The population sensed that the economy was in a disastrous state, but this was not fully articulated in public presumably because of the fact that the first all-German election campaign for the Bundestag took place in 1990. Political considerations were allowed to override economics, as the government wanted to create an appreciative psychological environment in East Germany. On the other hand, Chancellor Helmut Kohl seemed genuinely to have believed that the healing forces of the market would deal with the situation quickly. As a consequence, expectations were too high and were bound to be disappointed afterwards. Today, politicians have to grapple with a dramatic loss of credibility and perceived incompetence, which however has not affected the democratic system per se.

5. The choice of the right exchange rate proved to be critical to the unification process and future economic development. From a political point of view, however, the generous conversion terms of one to one and the formation of a currency union helped to pacify the population and making them feel accepted. There was a feeling among politicians that since Germany had accumulated large external surpluses amounting to some DM 500 billion, with the highest annual surplus of DM 108 billion registered in 1989, one could afford to tap these huge assets by printing the money and transferring it to East Germans, which would lead it was thought to a demand push for goods from the West. Within two years, there was a swing of DM 150 billion in Germany's current account and the surpluses turned into a deficit. Tensions built up not only on the balance of payments but also on the capital markets and short- and long-term interest rates. Hence, the German Bundesbank - largely motivated by the high inflation rate - felt obliged to pursue a policy of high interest rates which had serious international implications.

6. The exchange rate of one to one proved to be far too excessive, triggering economic and political problems later on. In effect, the East German currency was over-valued by about 300% which added to the non-competitiveness of East German products. As the difference in productivity between East and West amounted to a ratio of one to three, East German products could no longer be sold in any market of the world. In particular, as a result of the complete collapse of the economies of the former Soviet bloc, the traditional foreign markets for East German products withered away. Overall, this caused massive unemployment.

7. At the time of unification, East Germany automatically became a member of the European Community. While losing markets in the countries of the former Council for Mutual Economic Assistance (CMA), it also lost much of its ground domestically, due to superior competition from EC industries. Altogether this caused massive unemployment. Right now, the annual transfer of government funds towards East Germany is in the order of about US$ 100 billion.

8. In the third year after German reunification, economic development is much more uneven than expected. Industrial production is slower than prior to 1989 and the service industry is slacking. There are centres with impressive development as well as areas registering slow or even retrogressive trends. Two-thirds of public spending and development in the Laender of former East Germany is financed by massive public transfers from the West. As a result of such transfers, the per capita spending of the East Germans has almost doubled. There is very little internal growth and the negative impact of the decline in the industrial sector exceeds by far any growth in other sectors. It may take some 10 to 15 years in order to overcome the present low productivity levels. In the housing sector it may well require half a century.

9. In transferring to a market economy, it is not possible to leave everything to market forces. The deficiencies of the infrastructure in the former GDR were grossly underestimated as was the environmental contamination, the lack of modern technology. The political, legal, economic, educational, and social security systems changed, including traffic rules. It is an enormous achievement for the East German population to have coped with the stress created by this veritable revolution. But it also created distrust, lack of initiative, confusion, and fear all of which should have been more effectively addressed.

10. Post-unification economic progress was also hampered by the law and regulations governing the privatisation of state-owned industries and assets. The unification treaty stipulated that only state-owned enterprises, firms, and houses in East Germany were to be privatised and that, in principle, should be accomplished through a restitution to the former owners of properties or their heirs (1.8 million claims were registered). This has lead to fairly difficult legal situations as it could take some 10 to 15 years before each individual case is solved. Pending a settlement, nothing can be done with the property in dispute. This has impeded economic development further, as most foreign investors are horrified by the idea that they acquire a piece of property and may find at some later stage that because of restitution claims there ownership may be contested. This situation depresses the flow of foreign investment.

11. As the top-down command system was deemed incompatible with the horizontal system of the West, the laws and regulations of the former GDR were not retained. Instead, the West German legal system, its administrative laws and regulations and procedures - one of the most complicated systems in the world - were introduced virtually overnight to an area where the rule of law had hitherto little meaning. West German administrators and experts had to be assigned to East Germany, giving rise to a feeling of colonization among East Germans. The West German legal system with its formality and great number of appeal possibilities represents a barrier to speedy economic development and restructuring.

12. Despite all the television programme exchanges and postal exchanges and visits, the two Germanys knew very little about one another. As a consequence, there is a widespread disenchantment particularly in East Germany now. According to a recent survey, 48% of East Germans feel they are worse off now than before unification, 11% say they are not better off and only 41% indicate their lives had improved. The East Germans thought the Western world was much more secure, more beautiful and wealthier than it actually is. Neither the West knew the East nor did the East know the West. Most Germans in the East and West have still not realized what it means to unify a country. The West Germans still think it can be done quite easily, disregarding the considerable cost which has not yet sunk into the West German population at large. Germany made the mistake of telling West Germans that sacrifices were not needed at all. Something very similar is true for the East German population. The East Germans still believe they can go through this process without fundamental changes. They somehow still cling to old ideas and structures, and their willingness to change fundamentally is limited. The mental changes are excruciatingly slow in both parts of the country. Under present conditions, it will take East Germany up to 25 years to catch up with the West. The process of equalizing the standard of living between East and West may stretch over two generations.

13. While the unification of Germany was treated as a national issue, it actually has and will continue to have considerable international implications. Germany grew overnight from a country of some sixty million people to a nation of eighty million. Germany today is one and a half times the size of Britain, France or Italy. It is twice the size of Poland and more than five times the size of the Netherlands and twenty times the size of Finland. This creates naturally suspicion in the minds of almost all its neighbours. Although today Germany has enormous economic problems which will remain for at least the next 10 years, all of Germany's neighbours believe that in the end Germany will come out on top economically. In this context, the continued membership of a unified Germany in the European Community and NATO was a necessary reassurance to all of Germany's neighbours, including Russia.

III. SIMILARITIES AND DISSIMILARITIES BETWEEN THE GERMAN AND THE KOREAN SITUATION

14. German unification has demonstrated that the re-establishment of the unity of a country even after a long period of division and difficulties is possible and that unification can be achieved in a democratic, peaceful way. But despite similarities between the two cases, there may also be many differences regarding internal and external aspects.

15. Germany and Korea were both divided in the wake of World War II against the background of rivalry between the capitalist West and the communist East. In both countries, the hope for reunification was slim during the Cold War period. Unlike Germany, North and South Korea had fought a ferocious war. The two Germanys, unlike the two Koreas, concluded a system of treaties to regularise relations at the official level and to secure a modicum of civil contacts and communications among the people. On the Korean peninsula, North Korea remains to this very day a hermetically closed society. No information flows uncontrolled into the country, access to foreign radio and television broadcasts is non-existent and no contact is permitted with the outside world, not even the exchange of letters. Travel both inside the country and abroad is subject to approval and regulation. Kim Il Sung has ruled the country for nearly half a century and stamped it with his brand of Marxism and "chuche" nationalism. Apart from the country's leaders and nomenklatura, all other North Koreans are unaware of developments in the world in general and the social and economic conditions in South Korea in particular. This constellation is likely to make any unification process in Korea fraught with the risks of political and social instability.

16. There are also significant differences in the economic constellation between Germany and Korea. The population ratio between East and West Germany was 1:4, while for North and South Korea this ratio stands at 1:2. In 1990, North Korea is believed to have experienced an economic decline of 3.7% and in 1991 of 5.2%. South Korea has continued to achieve rapid economic growth in the past decades. This has brought about an ever-widening income gap. Today, the per capita income of the South is at least five times that of the North. This alone will make economic integration between North and South an exceedingly tough and complex task. North Korean GDP per capita corresponds to some 16% of that of South Korean, while East German GDP per capita stood at 25 % of West Germany's at the time of unification. North Korea's trade volume stood at US$4.7 billion in 1990 and US$ 2.7 billion in 1991. The decrease resulted from a slump in imports. South Korea's trade volume reached US$153 billion dollars in 1991. China and the former Soviet Union accounted for some 70% of North Korea's trade. Instead of barter or compensation trade arrangements of the past, they now demand payment in hard currencies which North Korea lacks. North Korea used to import millions of barrels of oil yearly from the former Soviet Union against coal and other raw materials, but currently it receives only 40,000 barrels producing an energy crunch with serious repercussions for industrial production and living standards. The utilisation of industrial capacities has actually fallen 40%. North Korean leaders seem to be beginning to open up their country to Western capital and technology. Most investments so far have come in the form of joint venture projects with pro-North Korean residents living in Japan (about 200,000 among one million Korean residents).

17. Unlike East Germany, a unification of the two Koreas will not entail ready-made access to new foreign markets for either of the two given the absence of an Asian common market. Protectionism in the United States and Europe - Korea's main export markets -threatens to erode Korea's export base and places South Korea in a vulnerable economic position. To assist any unification process in the future, the international community ideally would have to be more accommodating to Korea in the future. But given the present climate in global trade negotiations, it is unlikely that a unified Korea would be granted assured access to the European Common Market or the United States.

18. The differences between North and South Korea with respect to their industrial base are much different from those between East and West Germany. Unlike East Germany, North Korea relies essentially on large supplies of various raw materials most of which were traded on a barter basis with the Soviet Union before its demise. Korean unification may mean that additional markets could be tapped for their export. Given North Korea's limited trade exposure, any reduction in demand for its products following unification would therefore not pose a problem comparable to that experienced by East Germany. Currently, North and South Korea engage only in some indirect trade through Hong Kong, Singapore and Japan. Between 1988 and 1992, there were only some US$450 million worth of exports and imports between the two countries. In the German case, trade had steadily been growing between the two countries prior to unification, facilitated by a generous financial facility (the "swing") extended by the West German government.

19. North Korea is suffering from severe shortages of goods. In 1991, it produced 4.4 million tons of grains but consumed 6.5 million tons. Part of the shortfall was made up by a donation from South Korea. Following unification, South Korea as the stronger economy will have to take care of 22 million North Koreans, requiring substantial funds.

20. The North Korean economy is far more distorted than the East Germany economy was at the time of unification. It is also much more geared towards meeting military requirements than East Germany ever was. This may also complicate the eventual demobilisation of military personnel following unification.

21. Regarding labour costs, the gap between East and West Germany was probably higher than is the case for Korea. In Germany, gross labour cost increased following unification due both to the assimilation of wage levels towards levels prevailing in the West and to the introduction of the costlier social security system of the West. The Korean social security system is not very costly compared to the German.

22. In general, South Korea has not the capacity to bear the full cost of unification and might need to resort to higher domestic taxation and external borrowing on a large scale. Furthermore, South Korea is not in a position to offer generous aid programmes to other countries in exchange for their support for reunification.

IV. POSSIBLE RE-UNIFICATION SCENARIOS FOR KOREA

23. Several possible developments should be considered in any discussion of Korean reunification. In particular, there is a need to study the internal developments in North Korea. For one, Kim Il Sung's successor may change policies drastically or he may not do so. Either way, this could prolong the process of reunification, but could also yield benefits for the economic and social situation. Another scenario might be that of a revolt against the system and leadership by a part of the North Korean party elites. The consequences of such an event are entirely unpredictable. Another scenario would be the collapse of the North Korean economy leading to the absorption by the South. It is hoped that such an option can be averted in favour of a step-by-step approach to reunification. A further possibility would be a Chinese-style reform by opening up the country. The absence of any private ownership would complicate such an option, although the recent promotion of joint ventures might be a signal in the direction of such a reform. South Korea appears to be prepared to extend economic and social cooperation should such a course materialise.

24. Ultimately, both Koreas must have some kind of vision on the kind of country they would like to have after reunification. Gradualism has to be balanced against the risk of reversal. A gradual approach should only be pursued if it is certain that the process cannot be reversed. If there is a risk of reversal in political terms, a big bang approach would be preferable. If there is too much gradualism, the process may equally falter unless there is a critical mass of institutional change, which by itself is difficult to determine. The main task would be to prevent military complications during a transitional period that would precede unification. Thereafter would come a period during which both countries would be integrated. Above all, care should be taken that the international competitiveness of the South Korean economy be preserved.

25. The proposals made by the InterAction Council at its 1990 session in Seoul remain very relevant, calling as they did for contacts between North and South Korea, contacts between the North Korean elites and those of the South.

26. The German reunification had a specific, favorable external environment: the Soviet leadership pursued perestroika, dramatic changes took place in Poland, Czechoslovakia and Hungary, the Berlin Wall fell and relations between the Soviet Union and the West improved dramatically. In Korea, such conditions are non-existent. It will be important for Korea to develop good diplomatic relations with its neighbours, especially China and Japan. All countries having political and other interests in the region must be involved in the process - China, Japan, the United States, the ASEAN countries. It is incumbent upon Korea to foster an international climate conducive to its reunification process, for which it needs the assistance and consent of the world community. One particular issue of concern to the world community at large is the nuclear status of North Korea and how it will affect the status of a reunified Korea.

V. POLICY RECOMMENDATIONS

27. Generally, Korea should avoid rushing or getting pressurized into unification. It should preferably be a gradual process under controlled conditions. To that end, it is of utmost importance to prepare and to be prepared in case a political opportunity arises to unite in whatever steps and phases. Once the process has started, political decisions must be thoroughly interfaced and coordinated with economic policies and requirements. The transformation of a command economy calls for a most detailed planning in all areas. One factor of resistance to a transition may be the huge North Korean army, certain to be demobilised and fearful of large-scale unemployment.

28. It is estimated that in a big bang context, South Korea will have to transfer annually 8% of its GDP to the North for a 10-year period. Under more gradual conditions, some 3% of GDP may be required. To achieve parity in living standards might take more than 30 years. The unification of a country cannot be accomplished in the short and medium term without weakening the growth base of the economy - irrespective of the approach chosen. South Korean savings will need to be utilised as will be resort to foreign capital. Care should be taken that savings will not be diverted for consumption as this would undermine the economic base of the country. South Koreans must be aware that during the transition period their general economic conditions will change. As a result of unification, there will be an excess demand for capital and an excess supply of labour. In response, Government expenditures need to be reallocated and switched from the South to the North.

29. Irrespective of which approach will be chosen, the choice of a right exchange rate will be of paramount importance for the success of the transition. If possible, one should proceed on the basis of two currencies in order to have the exchange rate as a shock absorber. Too favourable an exchange rate would not only determine the actual exchange rate of wages, but it would also be the basis for the wage formation process in the future and shape the expectations of people in general. Wages should not be equalised too quickly as otherwise the rate of unemployment would increase inducing unwarranted migratory pressures. Free wage bargaining should also be restricted, since given the absence of capital owners in North Korea it would lead in a wrong direction.

30. Land reform in North Korea will be one of the first tasks during a transition. The experience gained by Korea in the post-world war II period may serve as a guide in this endeavour. Property rights issues will therefore play a prominent role after Korean reunification. There could be restitution of property rights to original owners if still alive, the sale of state-owned properties through public auction, a distribution of property rights to the general public through a voucher system, distribution of properties to actual users or a compensation in state bonds. The restitution approach might not be appropriate if early and effective incentives are to be given to foreign investors.

31. Privatisation is a means. Its objective is to introduce some elements of a market economy. In the process of privatisation of hitherto publicly owned enterprises, priority should be given to service and tourism establishments, such as hotels, as many visitors may be expected from the South. In the shift from a collective to a private agricultural system, serious problems are bound to arise. After 30-40 years of collectivism, there will be no more farmers, but only agricultural workers. In addition, the absence of fertilizers, tools, implements, equipment and vehicles such as tractors will complicate the task.

32. Industrial policies ought to be devised to respond to a variety of problems and challenges: the contamination of the environment, unemployment, social justice, concentration of economic power. Market forces are unlikely to create a productive economic structure in the North that will match that of the South. State interference, planning, and deliberate transfer of resources will be inevitable.

33. Public infrastructure - roads, energy, transportation, telecommunication, hospitals, schools and so on - are a precondition to make an economy function. Institutions administering a more market-oriented economy must be built and it must be decided what they will do and how they will be financed, where and in which time span. There will also be the need for massive human capital investment in terms of on-the-job and vocational training and retraining as well as the temporary transfer of managers, entrepreneurs and skilled administrators. Special adjustments will be required in the educational field, including new education curricula. At universities, the qualifications of university teachers and administrators should be reviewed. Present social welfare programs must be expanded to accommodate North Koreans.

34. Rules and regulations, licensing and permit procedures of South Korea should not be applied without modification to the North. Rather, new institutional arrangement should be devised for the North during the transition. There might also be merit in imposing some limit on relocations and movement by people from the North to the South. One proposal that deserves thorough study is the creation of a special administrative zone for North Korea with its own regulations, laws and currency. Even though it will be part of a unified Korea, it could be treated as a different part of the country for a certain period of time. In such a zone, special incentives could be offered for investors, employers and employees.

VI. HOW TO ORGANISE KOREAN TRANSITION

35. A wise management of the divided situation of the Korean nation is of utmost importance. Mismanagement could bring calamity to all Koreans and another Korean war must be avoided at all cost. The division of the country should be managed so as not to discourage the will of the people and national consensus for unification. Abrupt political integration between two societies whose diametrically opposed ideologies and economic systems would cause political chaos, confusion and frustration. The most desirable process would be a gradual integration through a network of reinforcing cooperative mechanisms and interactions so that the people of both societies can develop mutual trust and confidence.

36. In 1991, North and South Korea signed one overall treaty including the provision that it would absorb the armistice agreement of 1953. This treaty - which is more elaborate than the Basic Treaty of 1972 between East and West Germany - remains unimplemented. The major task is to deal with 10 million divided families; this should not necessarily lead to a massive movement of people. Rather, people should initially be allowed to meet each other at any place, time and condition.

37. National reunification between North and South Korea is on the face of it an intra-national issue. Yet, to create conditions conducive for unification and for stability on the Korean peninsula and in North-East Asia entails international implications. A sudden collapse of the North Korean regime may open the border on the Korean peninsula overnight just as the flood triggered by the collapse of the Berlin Wall in 1989. In the German case, the influence of the four powers - especially the Soviet Union - was very important. In the case of Korea, the relations with the neighbouring powers are quite different. Korea is a very small country compared to its neighbors and has never threatened the security of the surrounding nations. Korea does not need to grab a window of political opportunity as Germany did. It might therefore prepare for a more deliberate pace to manage the process of reunification.

38. Korea should woo the three major powers it counts as neighbours - Russia, China and Japan. The future of North Korea is closely linked to developments in China. The way in which the Chinese look at the Korean peninsula will be of great importance in the future. The United States of America and the South-East Asian states can also be considered as neighbours vis-a-vis the seas. The four major powers and the group of medium-sized powers in South-East Asia should be considered as future economic partners and approached accordingly. Korea should also address itself to the capacity for fierce competition between a future united Korea and advanced Japan corporations and industries. Korea right now is a country of 43 million people, after reunification it will be around 60 million. Sixty million Koreans are not an order of magnitude to match either the 150 million Russians or the 1 billion Chinese or the 120 million Japanese. Yet, a united Korea must be considered a major factor in the Far East and in the world economy as a whole.

39. A solution of the nuclear armament issue will be a precondition for the resumption of the dialogue and economic cooperation between the two Koreas. The international community is concerned at the specter of North Korea acquiring nuclear arms and thus violating the nuclear non-proliferation treaty (NPT). Beyond that, there must be assurances about the future military set-up of a united Korea. The adherence to the NPT is but one aspect. A Korea of 60 million will be quite a force to reckon with. To assure all neighboring countries of Korea's peaceful intentions in the future, there must be unequivocal commitments that Korea does not intend to change any borders - as was done by the German Parliament with respect to the Polish border.