President Trump and North Korea's leader Kim Jong Un held a long-anticipated summit meeting that marks a potential turning point for the Korean peninsula and the region at large. In this Q&A, Portfolio Manager Michael Oh discusses the longer term implications for investors.
What positive outcomes do you see from the recent U.S./North Korea summit?
The summit was an important step toward greater understanding and cooperation on the Korean peninsula. Despite major issues left to resolve, the meeting showed how dialogue and communication can guide the road forward. One important outcome is a significant reduction in the risk of military conflict. Of equal importance is the opportunity for the two Koreas to potentially form closer economic ties over time. Increased trade with neighbors—such as China and South Korea—would improve the quality of life for North Korea's 25 million citizens. North Koreans could represent a large base of new consumers, workers and savers for many Asian companies. Thus, greater cooperation on the Korean peninsula can potentially benefit the entire region.
How were the talks different from past meetings?
As the first time a sitting U.S. president met with North Korea's top leader, the summit was an historic event. If Kim Jong Un can normalize diplomatic relations with the U.S., there would be significant benefits for the people of North Korea. Kim received part of his education in Switzerland and may have a more modern outlook than his father or grandfather. He has likely seen firsthand how a market-based economy can offer a better quality of life. If Kim feels politically secure, he might be more inclined to open his economy to more global trade. As a young leader in his 30's, Kim may potentially rule for another three decades. His prospects for a long reign could allow him to take a longer term view on economic development than his predecessors. Notably, Kim's father and grandfather were in their 50s and 60s when they met with South Korean leaders, so it may have been harder for them to focus on economic reforms as they had a much more immediate need for succession planning. There is obviously still a long way to go toward improved relations between North Korea and the rest of the world, but I remain optimistic that progress is possible.
What is the potential upside for South Korea's economy and equity market?
If North Korea slowly opens its economy, there would likely be attractive long-term economic benefits for South Korea. Manufacturers in South Korea are already turning to lower-wage countries, such as Vietnam, to expand their labor pool. If the two Koreas were to develop a cooperative framework for regulations and trade, North Korea could potentially attract new manufacturing jobs from South Korea's private sector. What's more, the North Korean literacy ratio for workers ages 15 and older is nearly 100%, providing access to a highly literate, lower-cost workforce for South Korean companies.
As military tensions ease, South Korea's stock market may also attract increased interest from both domestic and global investors. Stocks in South Korea historically have traded at lower valuations than equities in other similarly developed Asian markets. If investors feel more confident about South Korea's long-term national security, then the current discount in valuations associated with Korean equities may be reduced. The fundamentals of South Korean companies remain strong and we believe the equity market is attractive for long-term investors. Maintaining a long-term perspective is key, as any potential benefits from the summit will likely be long-term—rather than short-term—in nature.
What are some of the potential costs and risks for South Korea?
Economic reunification could present some fiscal costs for South Korea. Expansionary fiscal policies and fiscal transfers from South to North could widen fiscal deficits. The cost of an economic reunification is estimated to be 4% to 5% annual of South Korea's GDP for 20 years.1 The overall cost would likely be spread out over a period of several decades, following a step-by-step process for building closer economic ties. North Korea's economy would probably need to rise to a higher level of GDP before the deeper political ties could be formed between the two Koreas. The Bank of Korea estimates that North Korea's per capita income, at US$1,200, is less than 5% of South Korea's, using 2015 data.2