Fiscal Sustainability of the South Korean Welfare State - Projections Concerning Inter-Korean Integration

Abstract

This study aims to empirically determine the fiscal capability of the South Korean welfare state to withstand the inevitable increase in welfare spending that would be incurred as part of the cost of unification with North Korea. We explicitly assess and compare South Korea’s fiscal sustainability both under integration with North Korea and the absence of integration, with the likely changes in the demographic structure and unemployment rates. It then examines how South Korea’s fiscal sustainability would be affected under the worst imaginable macroeconomic circumstances that could arise after inter-Korean integration. The analysis reveals that the South Korean welfare state is fiscally robust. Insofar as the Korean government maintains its current fiscal stance (effective as of 2015), it would most likely ensure the fiscal sustainability of its welfare programs. Even when North Korea’s demographic structure and labor market situation are taken into account, South Korea could manage its fiscal sustainability competently. In such an extreme case, where the country’s national debt level is double the 2015 level, and the country faces a sudden economic crisis like the Asian Financial Crisis of the 1990s, its fiscal sustainability could be compromised. In reality, however, the chances of such an abrupt and unforeseen deterioration in a country’s economic status are slim. Therefore, we should take caution not to exaggerate the likelihood of such scenarios, even as we prepare for the possible risks of the worst-case fiscal scenario. The best way to reduce uncertainty as much as possible is to establish and strengthen mutually beneficial relations between the two Koreas.