The Economic Unification of Germany
Nowadays, German politicians tend to see the German unification as a success story. However, as far as the economic unification is concerned, this seems to be more than questionable. Indeed, many economists belief it was a complete disaster.1
The central event was the economic and monetary union of July 1st, 1990. The way this reform was realized set the economic conditions and irreversibly determined the economic path of the new German states which were politically appended to the BRD three months later, on October 3rd, 1990. Importantly, this event implied an immediate and complete integration of the centrally planned East German economy into the (capitalist) West German market. The extent of the subsequent economic depression is the strongest an industrialized country has ever suffered in peace times: Industrial production fell to 49% of its level by the end of 1990, during 1991 it was only a third of was it was before the monetary and economic unification.2 Employment was almost halved in less than 2 years: The number fell from roughly 9.5 million to 5 million in the early 1992.
The questions one is immediately tempted to raise are the following: Why was the collapse much more dramatic than even pessimist had expected? Could it have been mitigated? This is even more acute when taking into account the fact that the GDR was in a privileged position with respect to other post communist countries: Not only had it the BRD as a “big brother” at his side which provided massive financial transfers, but it was from the first moment endowed with the functioning West German legal and political institutions, a necessary requirement for every economy to work. And yet it was hit harder than any other ex-communist “brother states”.
The economy of the GDR is most frequently characterized by the deplorable capital stock and a high level of pollution. But there is a range of inherent inefficiencies at the firm level which make them less competitive when compared to the capitalist system. Due to the fact that the “raison d’être” of a firm in a centrally planned economy is to fulfil the production plans issued by the central government, they lack incentives to transfer technology, innovate and invest in know how. Furthermore, the central allocation system induces a range of organizational defects: Oversize warehouses, poor staff organization, underdeveloped marketing. Additionally, firms had the character of social clubs where productive activities sometimes played a subordinate role in order to help prevent “the alienation of man from his labor”, as claimed by Marx. This adverse incentive system within firms and between firms and the government is complemented by non-market prices which do not reflect true scarcities (in fact, scarcities are reflected by long queues instead of high prices). Relative prices hence tend to shift dramatically once the economy is exposed to the rough conditions of a capitalist system. Changing relative prices require a huge investment to reshuffle the production process and firm organization after unification. Those “system – inherent” inefficiencies are partly responsible for the economic depression common to all post-communist countries. However, it is particularly important for the GDR which was more deeply committed to the communist ideology than the other East European countries.
However, apart from this inherited burdens, the German government has been harshly critized not only for merging economically the 2 Germanys instantaneously, but also by the exchange rate, by which the GDR currency (Ost-Mark) could be converted into the West-Mark. Admittedly, to determine the value of the Eastmark was everything but an easy job. Neither did an official exchange rate exist, nor was the Eastmark traded on an international currency market. And the black market exchange rate (ranging from 1:3 (Westmarkt-Eastmark) to 1:10) was by no means representable.
In order to determine the value of the Eastmark, the differences in purchasing power of the two currencies had to be taken into account. But how to determine the purchasing power of the Eastmark, where people are supposed to change their consumption pattern dramatically once they have the possibility to get the whole varieties of West German products for which they were deprived for decades? How to quantify the purchasing power in the GDR when the role of money was completely different due to its economic system?
The decision taken by the government was the following: Flow variables, like rents, pensions, and, importantly, wages were converted 1:1. Stock variables, like the amount of debts and liabilities were converted 2:1. The fact that wages were converted 1:1 is seen as one of the major reasons which deepened the crisis fundamentally. Wages converted at the rate of 1:1 would have been justified if productivity in the East were the same as in the West. This was by no means the case. Indeed, wages in other post-communist countries were at around 30% of West German wages. Many people belief that a lower level of initial wages would have saved many firms as it had implied an increased competitiveness. Firms now had to operate in very adverse conditions: On the one hand, their labor costs increased substantially. On the other hand, they produced goods for which they faced competition by technologically superior West German competitors. Furthermore, their products were stigmatized with the label “made in GDR” – a synonym for low quality. In short, they faced a market economy without a market. Overall, the exchange regime was consumer friendly but had extremely adverse effects on the productive sector.
In order to determine the value of the Eastmark, the differences in purchasing power of the two currencies had to be taken into account. But how to determine the purchasing power of the Eastmark, where people are supposed to change their consumption pattern dramatically once they have the possibility to get the whole varieties of West German products for which they were deprived for decades? How to quantify the purchasing power in the GDR when the role of money was completely different due to its economic system?
The decision taken by the government was the following: Flow variables, like rents, pensions, and, importantly, wages were converted 1:1. Stock variables, like the amount of debts and liabilities were converted 2:1. The fact that wages were converted 1:1 is seen as one of the major reasons which deepened the crisis fundamentally. Wages converted at the rate of 1:1 would have been justified if productivity in the East were the same as in the West. This was by no means the case. Indeed, wages in other post-communist countries were at around 30% of West German wages. Many people belief that a lower level of initial wages would have saved many firms as it had implied an increased competitiveness. Firms now had to operate in very adverse conditions: On the one hand, their labor costs increased substantially. On the other hand, they produced goods for which they faced competition by technologically superior West German competitors. Furthermore, their products were stigmatized with the label “made in GDR” – a synonym for low quality. In short, they faced a market economy without a market. Overall, the exchange regime was consumer friendly but had extremely adverse effects on the productive sector.
Remarkably, despite the extreme economic downturn in the GDR, East Germans did not feel as losers immediately after unification. Due to the favourable exchange rate (from their point of view) and the expectation not least feed by unrealistic promises from politicians made them optimistic about the future at the beginning of the 90s. Since then, a huge amount of money was transferred to the new states – estimates figure around 1,2 billion Euros between 1991 and 2003. However, the economic landscape of Germany today, 19 years after reunification still displays a huge gap in performance between the West-German states and its eastern counterparts. And there is little hope that the standard of living and annual income in the new states will reach the West German level by 1019 as planned by the federal government. In that year, the public transfer system (Solidarpakt II ) will expire.
1 See for example Ulrich Busch: „15 Jahre Währungsunion – Ein kritischer Rückblick.“ http://www.linksnet.de/de/artikel/19307
2 All numbers are from „Jumpstart – The Economic Unification of Germany“. Sinn & Sinn. The MIT Press, 1992
