The North Korean military threats are not feared

Posted by on 7 April 2009

From Kim Byung-Yeon and Gerard Roland.

The launch of a multi-stage rocket by the North is yet another episode in the build-up of tension by the North Korean regime. The regime of Kim Jong-Il has showed its willingness to establish a nuclear program and there have been multiple episodes in recent years of military provocations by the North Korean regime. Adding to that is their tough stance against President Lee Myung-Bak, the freezing of relations between both Koreas and the very aggressive rhetoric in Pyongyang. How much should we fear the North Korean threat?

Interestingly, this threat is perceived more dramatically in the international media than where it should be feared the most, i.e. in South Korea. We have studied whether any of 20 major events related to North Korea between 2000 and 2008 had had any significant effect on financial markets in South Korea (the Soutch Korean Stock Market Kospi index, the exchange rate of the Won and bond yield spreads). These events include the Northern Limit Line Naval Engagement of July 2002, the test-firing of 7 test missiles on July 5 2006, the conduct of the nuclear test of October 9 2006 and other military or political events related to the North Korean threat. We did this using event study methodology, a method that allows analyse of how markets perceive a particular event or information. Since people make and lose money on markets, financial markets are affected by the opinions of a myriad of market participants. While the opinions expressed on markets do not always come true, they tend to be more accurate than the opinions of experts.

Our results are quite striking. We found basically no effects on financial markets of events perceived as increasing the tension on the Korean peninsula. In a nutshell, the financial markets in South Korea are not afraid of Kim Jong-Il. A similar effect is to be expected in relation to Sunday’s North Korean rocket launch since this recent event is arguably less dramatic than some of those we tested.

These results give clarity as to what policy is best towards North Korea. We should not fear its rhetoric or its provocations. We should not let it intimidate us. The North Korean regime is not more dangerous since April 5 than it was before. It is thus important to keep calm and of course to continue talking with Pyongyang and resume the six party talk. But we should not give in to their provocations. The South Korean government should not let itself be bullied into giving more money to maintain the regime in place for a few more years. Assistance to the North Korean population must be monitored to make sure it reaches its recipients. Negotiations must continue to achieve the full denuclearization of North Korea. Last but not least, countries that are part of the Six Party Talks must jointly prepare to deal with an emergency situation in case of a regime collapse in Pyongyang.

Kim Byung-Yeon, Seoul National University  
and
Gerard Roland,
University of California Berkeley