How a Second Korean War Would Harm the U.S. Economy

Markets would panic at first. but war probably wouldn't cause another recession.

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Every nation that takes on the U.S. military loses. So the armchair generals gaming out a war on the Korean peninsula typically assume that if fighting erupted, North Korea could bloody the South but would quickly be crushed as American forces and their South Korean allies retaliated with overwhelming force.

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Real generals know, of course, that wars are messy, unpredictable, and never the cakewalk that desk jockeys tend to predict. In fact, if the recent saber-rattling between North and South Korea escalated into outright war, it could be far bloodier, and exact more damage on the global economy, than most people imagine.

Back in 1953, when the armistice halting the war went into effect, Korea was considered a geographically strategic landmass, but its role in the global economy was insignificant. That has changed. South Korea is now a prosperous democracy with the world's 15th largest economy. It's the home of prominent global corporations such as Samsung, Hyundai and LG. As the sixth largest trading partner of the United States, South Korea plays a key role in the global supply chain for many important products.

North Korea remains a backward, feudal dictatorship, yet it has the ability to lob chemical, biological and nuclear weapons into South Korea or Japan, and enough conventional firepower to roil all of Asia. And military experts doubt U.S. and South Korean forces could silence the North Korea's guns quickly.

"It could easily take months," says Bruce Bennett of the Rand Corporation, which conducts detailed research for the Pentagon. "Even people in the U.S. military don't like to think about the damage that a war could do, including the economy."

There's little doubt U.S. and South Korean forces would ultimately prevail in a war. But for days or weeks, North Korea could bombard Seoul, South Korea's capital, with artillery and missiles. Bennett estimates that could damage or destroy 10 to 15 percent of South Korea's GDP, while also terrorizing citizens and causing panicky refugee flows.

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The use of nukes or other weapons of mass destruction is much harder to quantify, but it would obviously be disastrous. The use of chemical or biological weapons would produce a health emergency that could spread beyond the Korean peninsula if, for instance, Americans unknowingly infected with smallpox fled Korea and returned home. If North Korea, which has perhaps 5 to 10 rudimentary nukes, fired one or more of them, disbelief would promptly yield to mayhem.

"The impact on markets and global confidence would be shattering," says Nariman Behravesh, chief economist at forecasting firm IHS Global Insight.

It's facile to assume America would respond to a North Korean nuclear attack by incinerating Pyongyang.

"No U.S. president would kill 10 million innocents in North Korea," Bennett asserts. Besides, North Korea could have its nukes hidden in mountain caves or subterranean bunkers. And experience in Iraq and elsewhere has made clear that enemy leaders can easily hide from the Pentagon's mind-bending surveillance gear, at least for a while. So it's possible that a kind of nuclear cat-and-mouse game could ensue as allied forces gradually overwhelmed the large but brittle North Korean military and destroyed its launch capability.

Once the fighting was over, both South Korea and China would face a massive flow of North Korean refugees. If the two Koreas united, it would be enormously costly for the south, and probably more chaotic than the reunification of East and West Germany after the fall of the Berlin Wall, because of the primitive conditions in the north.

If there's any good news—for westerners, that is—it's that the worst fallout from a war would probably remain contained to the Korean peninsula. The one exception might be a nuclear attack on Japan, a long-standing North Korean foe. For all its bluster, North Korea doesn't yet have the capability to strike the United States.

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So in the worst-case scenario, the economic damage would ripple outward from Korea and perhaps Japan. While the shock and uncertainty caused by a war would clearly rattle the global economy, the region doesn't control the supply of a vital commodity such as oil, and a war wouldn't threaten vital shipping lanes such as the Strait of Malacca that links the Indian and Pacific oceans, or the Strait of Hormuz at the mouth of the Persian Gulf.

"I don't think it would trigger a recession at the global level, as it would if oil hit $200 a barrel," Behravesh says.

Some South Korean industries and companies could end up devastated. Many U.S. firms would have to find other suppliers, similar to what happened after the Tohoku earthquake and tsunami struck Japan in 2011. But the economy would gradually adjust to those disruptions.

South Korea itself would probably reap huge amounts of rebuilding aid. Plus, South Korea has already shown itself to be a feisty and ambitious economic power, and unification with North Korea might eventually give it standing to challenge China's economic might. That, however, is many turns in the future, beyond a nightmarish sequence of events that most reasonable people hope never to witness.

Rick Newman's latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.