Two Koreas dialogue final chapter in Cold War

North-South dialogue in Korea could herald big changes to business and finance on the peninsula and affect the rest of Asia.

The news that North and South Korea are to hold a summit on June 12-14 could be the beginning of the final chapter in Cold War history. If reconciliation happens what will it mean for South Korean and Asian business and finance?

Firstly, it is important to realize that a lot can happen between the announcement of a summit and any official thawing of attitudes: the last time a summit was announced in 1994, the Dear Leader Kim Il-Sung, died of a heart attack just days before the historic meeting. It has taken six years for the two sides to agree to meet again.

Moreover, the ever-prickly North Koreans can change their stance very quickly, resorting to belligerence and threats as internal economic and political conditions demand.

Nevertheless, if a rapprochement does occur there will be serious consequences for South Korea and the rest of Asia.

The latest thinking in the South Korean government is that the ideal situation would be that the two Koreas form a confederacy of two independent states that maintain very close economic ties. This would enable North Korea to become an extremely cheap manufacturing base for South Korean and international companies. Cheap labour, cheap land and strong rule of law in the North would be an almost irresistible draw for many South Korean and international manufacturing companies.

Cheap labour

Inevitably, this draw of foreign direct investment (FDI) could result in less FDI going to other Asian countries that have hitherto won much of the Asian inward investment based on their cheap labour and even cheaper human rights records.

China, Thailand, Vietnam and Indonesia could all see their FDI inflows diminish as the money and factories move to North Korea.

Another scenario is that North and South Korea eventually reunite along the lines of East and West Germany in 1990. This would place a huge burden on South Korea as it would bear almost the whole cost of reunification. Standard & Poor's estimates that the cost of reunification for South Korea could be as much as 200% of GDP - in the process blowing the country's finances by greatly increasing its debt.

Spreads would widen, the won would weaken and the country's brittle labour market would face massive internal pressure. These are consequences already seen in the German example. But interestingly they were also the effects of the liquidity crisis that engulfed South Korea in 1997. The speed with which South Korea renewed itself after that liquidity crisis makes one cautiously optimism that the country could handle another large external shock such as reunification with North Korea.

Reunification costs

Moreover, the costs of reunification would be mitigated by the lower political risks that peace would bring. It would allow South Korea to benefit from the peace dividend that the US and Western European countries have enjoyed during the 1990s in that peace would allow them to drastically reduce their defence spending.

With less government spending goes lower taxes, less debt and quicker growth. In South Korea's case the effect would be even greater than it was in the west as much of the money it spends on defence is spent abroad buying weapons and armaments. Europe and the US supported vast indigenous defence industries, which were some of the biggest losers of the end of the Cold War. Korea would have little such domestic loss, so the peace dividend would be even greater than in the west where cuts in defence spending hurt domestic industry.

The ramifications of what improved relations mean for the business and finance community are far from clear as yet. All it is possible to say is that in every South Korean company of size, teams of corporate planners are looking at the various outcomes of talks to see how they can make money out of the North.

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