North Korea's Economic Integration and Growth Potential

This paper analyzes the future growth potential of the North Korean economy, conditional on economic reform and integration with South Korea. The growth projections based on cross-country evidence show that, if North Korea embarks on substantial policy reforms toward a market-oriented and open economy, it could achieve higher economic growth in the long run. Using an empirical gravity model of trade and direct investment, we forecast that, when the two Koreas pursue economic integration and cooperation without military conflicts, North Korea’s trade with South Korea can increase significantly, that is, up to 36 percent of North Korea's gross domestic product (GDP) and its foreign direct investment (FDI) flows from South Korea up to 6 percent of GDP. Overall, by promoting trade and FDI integration with South Korea, North Korea can boost its GDP growth by about 3 percentage points per year. Combined with a market-oriented reform, which can bring an additional boost to GDP growth, the North Korean economy could grow by about 4.7 percent per year over the next decades. Conversely, if more rigid sanctions imposed on North Korea become effective, its trade and investment will decrease and its GDP growth rate is expected to fall by approximately 2 percentage points per year.