Investment update 26 February 2018

Last week in the markets

Over the past week Australian shares were up 1.8% while small company shares were up 3%. Shares in developed countries rose 0.1% with the US market up 0.6%. Shares in emerging markets were up 1.4%. The Australian dollar fell 0.8% to 78.43 US cents. The Australian 10 year bond yield fell to 2.85% while the US 10 year bond yield was unchanged at 2.87%. The oil price increased 3% to 63.55 US dollars per barrel.

Korean unification and the Five Rings of Kim Jong-un

On Sunday the Winter Olympics ended. The Winter Olympics seems like a collection of the strangest and most dangerous sports. From the peculiar sport of Curling, which involves scrubbing ice to alter the trajectory of a heavy granite stone, through to the appropriately named Skeleton, plummeting head-first down a steep and treacherous ice track on a small sled.

There was something else a little peculiar in the 2018 Winter Olympics – North and South Korea competed together under the Korean Unity flag. This display was grand and well-televised. But was it a meaningful indicator for the future of the two Koreas?

In the Winter Olympics of 1956, 1960 and 1964 German athletes from West and East Germany competed as the United Team of Germany. In 1989 the Berlin Wall came down and German re-unification began (see last week’s investment update). On the surface, the grand show of Korean unity might seem important. But the differences between the divided Korea of 2018 and the divided Germany of 1990 are stark.

What might be the drivers for Korean unification?

  • Both Germany and Korea were divided after wars involving international powers and the two key ideologies – democracy and communism.
  • Like East and West Germany, North and South Korea have a common language and culture. However, the time in separation for the two Koreas is 25 years longer than East and West Germany in 1990.
  • The younger generation in South Korea have little real connection with relatives in the North and the motivation to bear unification costs may not be strong. However, a desire for stability and security might overcome this.
  • In 1989, East Germans were aware of what was happening in the wider world and the better living standards in West Germany, which in part fuelled the desire for change. It’s reasonable to assume, however, that most North Koreans have little understanding of living standards in the South and have a counterfactual understanding of the wider world.

So, despite the common ground, it seems unlikely that the desire for personal freedom and better products could motivate mass protests, never mind a large scale breach of the demilitarised zone.

And what of the costs?

  • North Korean Gross Domestic Product (GDP) per-capita is very low and the population today is far higher than that of East Germany in 1989. The cost of Korean unification would be borne by the South Koreans; by one estimate this would be 165% of GDP over 25 years. This cost is far greater than that borne by the West Germans during German unification.
  • The healthcare and social welfare costs would be immense. It’s estimated that about 40% of the North Korean population is under-nourished.
  • Without the assistance of the International Monetary Fund it seems unlikely that a unified Korea could afford the spending on infrastructure and social welfare seen in Germany in the years following 1990.

And what are the economic consequences?

  • The bulk of the North Korean population is poorly educated and accustomed to a command-control environment. It would be difficult to integrate this pool of labour into the modern South Korean economy. This suggests that the time taken for the output of the Korean economy to rise sufficiently would be far greater than that of Germany in the years after 1990.
  • The existing industries in North Korea would not be sustainable post-unification since they rely on slave labour.

So what should we make of the Winter Olympics?

The show of unity seems to be about politics and diplomatic manoeuvres. The South Korean President needs to deliver on his promise to engage with the North. North Korea’s leader Kim Jong-un is thought to be attempting to drive a wedge between the US and South Korea.

Unfortunately for the people of North Korea, a peaceful unification, like that which improved the lives of East Germans, seems distant. If Korean unification occurs then it will probably be the result of regime change in North Korea or a military coup. In the meantime, the people will suffer and the risk of military conflict with the US will persist.


Signing off

Sean Anthonisz | Senior Quantitative Analyst