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The Reunification of Germany and Its Aftermath
The East German and West German economies at the time of unification
looked very similar. They both concentrated on industrial production,
especially machine tools, chemicals, automobiles, and precision manufactures.
Both had a well-trained labor force and an important export component,
although their exports went largely in opposite directions. But the East
German economy was highly centralized and guided by a detailed and purportedly
precise planning system, with virtually no private property and with no
room for decision or initiative.
On July 1, 1990, the economies of the two Germanys became one. It was
the first time in history that a capitalist and a socialist economy had
suddenly become one, and there were no precise guidelines on how it could
be done. Instead, there were a number of problems, of which the most severe
were the comparatively poor productivity of the former East German economy
and its links to the collapsing socialist economies of the Soviet Union
and Eastern Europe.
Even before economic unification, the West German government had decided
that one of its first tasks was to privatize the East German economy.
For this reason, it had taken over in June the Treuhandanstalt (Trust
Agency, commonly known as Treuhand), which had been established by the
GDR to take over East German firms and to turn them over to new management
through privatization. The agency assumed the assets and liabilities of
about 8,000 East German enterprises in order to sell them to German and
other bidders. By the time the Treuhand was disbanded at the end of 1994,
it had privatized some 14,000 enterprises.
As economic unification proceeded, issues that had been recognized but
inadequately understood in advance began to surface. There was massive
confusion about property rights. As wave after wave of Nazi, Soviet, and
later GDR expropriations had taken place between 1933 and 1989, there
was often little knowledge of the actual ownership of property. More than
2 million claims on properties in the territory of the former GDR were
filed by the December 31, 1992, deadline. As more claimants emerged, with
many winning cases in the courts, potential investors were often scared
Another problem was that East German production costs had been very high.
The conversion rates of East German marks to deutsche marks often kept
those costs high, as did the early wage negotiations, which resulted in
wages far above the productivity level. Western German firms found it
easier and cheaper to serve their new eastern German markets by expanding
production in western facilities.
A third problem was that the inadequate infrastructure also became a
problem for many potential investors. Telephone service was improved only
very slowly. Many investors also complained about energy shortages, as
many East German power stations were shut down for safety and other reasons.
Roads and railroads had to be virtually rebuilt because they had been
so badly maintained.
In addition to these practical problems, there was also a deep policy
dilemma that underlay the entire process of unification. From the beginning,
there had been a pernicious link between the earlier and later phases
of the East German transition to a free-market economy. Policies calculated
to make the initial adjustment as painless as possible hampered long-run
growth and prosperity. Real economic efficiency could only be achieved
by permitting and even forcing considerable immediate dislocations, whereas
temporary compromises might lead to permanent structural burdens. However,
excessive disruptions could jeopardize the economic and political stability
required for a smooth unification process and might also cause streams
of East Germans to move west. The government was never able to solve this
dilemma. When it was forced to choose, it usually selected the more expensive
and slower course to encourage persons to stay in the east.
Despite these problems, the process of unification moved ahead, albeit
slowly. The Treuhand, staffed almost entirely by Germans from the west,
became the virtual government of eastern Germany. In the course of privatization,
the agency decided which companies would live and which would die, which
communities would thrive and which would shrivel, and which eastern Laender
would be prosperous and which would not. It also decided who might or
might not buy eastern firms or services.
Whether correct or not, reports persisted throughout the first years
of unification that foreign enterprises were being screened more carefully
and more skeptically than German firms even as they were being invited
to invest. Less than 5 percent of all investment in eastern Germany was
non-German, and most of that was from companies with subsidiaries in western
Germany who were expanding them to the east. The Japanese did not invest,
although they had earlier expressed some interest, and the offices Treuhand
established in New York and Tokyo found few investors.
As might have been expected, the economy of eastern Germany went into
a deep and precipitous slump immediately after unification. Within a year
after unification, the number of unemployed rose above 3 million. Industrial
production in eastern Germany fell to less than half the previous rate,
and the total regional product fell precipitously through 1991. One estimate
was that in 1991 the entire production of eastern Germany amounted to
less than 8 percent of that of western Germany.
Because the process of unification was managed by persons from western
Germany, new eastern firms were usually subsidiaries of western firms,
and they followed the western ownership and management patterns. Bank
participation became customary, especially because the large Frankfurt
banks assumed the assets of the former East German State Bank, and most
eastern firms thus owed money to those Frankfurt banks. The banks installed
their representatives on the boards of the new firms and assumed some
supervisory functions--either directly or through control by western firms
with bank representation. The Treuhand had close contacts with western
German banks. Many of its employees came from those banks and planned
to return to their jobs at the banks.
Because of these circumstances, private investment and economic growth
came to eastern Germany at a relatively slow rate. Little new equity capital
flowed in. Investment during the early years of unification was only 1
percent of the all-German GDP, when much more was needed to jump-start
the economy of eastern Germany. Much of the investment was for the purchase
of eastern German companies, not yet for their rehabilitation. Many western
German firms bought eastern firms on a standby basis, making sure they
could produce in the east when the time came and paying enough wages to
satisfy the Treuhand but not starting production. Many others, including
Daimler-Benz, did not even meet the commitments that they had made when
they had purchased the eastern German firms from the Treuhand. Thus, western
German private investment was not strong enough to boost the eastern German
As private funds lagged, and in part because those funds lagged, federal
budget investments and expenditures began flowing into eastern Germany
at a consistently high rate. Government funds were used essentially for
two purposes: infrastructure investment projects (roads, bridges, railroads,
and so on), and income maintenance (unemployment compensation, social
security, and other social costs). The infrastructure projects sustained
employment levels, and the income maintenance programs sustained income.
But neither had an early growth payoff.
Although the precise level of German official expenditures in eastern
Germany has been difficult to estimate because funds appropriated in one
year might have been spent in another, it is beyond dispute that the federal
government expended well over DM350 billion in eastern Germany during
the first three years after economic, or monetary, unification. After
1992 this requirement has continued at an annual level of around DM150
billion, so that the sum of private and public funds put into eastern
Germany during the half-decade between monetary unification in 1990 and
the end of 1995 would probably amount to at least DM750 billion and perhaps
as much as DM850 billion. Between one-fifth and one-fourth of those funds
were private, and the remainder were government funds. This constituted
an infusion of outside money of about DM50,000 for every resident of eastern
Germany, a far greater level of assistance than contemplated for any other
area that had been behind the Iron Curtain and a token of German determination
to bring eastern Germany to western levels as quickly as possible.
As eastern Germany went into a deep recession during the first phase
of unification, the western German economy went into a small boom. Western
German GDP grew at a rate of 4.6 percent for 1990, reflecting the new
demand from eastern Germany. The highest growth rate came during the second
half of 1990, but growth continued at only a slightly slower pace into
early 1991. Prices, however, remained relatively stable because the cost
of living grew at only 2.8 percent despite some high wage settlements
in some industries. Employment rose during the year, from 28.0 million
to 28.7 million, and the unemployment rate sank to 7.2 percent. Notably,
the number of registered unemployed in western Germany only declined by
about 300,000, showing that at least half of the new jobs in western Germany
had been taken by persons who had moved to or were commuting from eastern
The dramatic improvement in the western German figures resulted from
the opening in eastern Germany of a large new market of 16 million persons
and the simultaneous availability of many new workers from eastern Germany.
Many easterners did not want the shoddy goods produced at home, preferring
western consumer products and food. Moreover, many easterners were coming
to the west to work. By the end of 1990, as many as 250,000 were commuting
to work in the west, and that number was estimated to have grown to 350,000
or even 400,000 by the middle of 1991.
This meant that western Germany not only had a vast new market but also
a growth of over 1 percent in its workforce, as sharp an increase as since
the days of the economic miracle. It also increased its capital base because
eastern German deposits were placed in western German banks that had come
east and because those deposits moved back to the central German financial
market at Frankfurt.
The Bundesbank became worried about three elements of the sudden boom:
the sudden financial shifts between east and west, which led to a jump
in money supply; government deficits resulting from large expenditures
in eastern Germany; and the potentially inflationary effects of a rapid
growth rate in the west. The bank warned that interest rates would have
to remain high to keep price increases under control. The bank raised
short-term interest rates sharply through 1991 and 1992, with the average
rate of short-term interest climbing from 7.1 percent in 1989 to 8.5 percent
in 1990, to 9.2 percent in 1991, and to 9.5 percent in 1992. The Bundesbank
permitted rates to begin falling only in 1993--to 7.3 percent--when it
believed that the inflationary pressures had been contained by the recessionary
effects of the credit squeeze.
As the Bundesbank's policies began to take hold, growth slowed in western
Germany, from 4.2 percent in the first quarter of 1991 to 0.8 percent
in the last quarter of 1992. For all of 1992, the western German growth
rate was 1.5 percent, a decline from the 3.7 percent rate of 1991 and
even more from the 4.6 percent rate of 1990. The eastern German growth
rate was 6.1 percent during 1992, well below the 7 percent to 10 percent
growth rate originally anticipated for the region. The number of employed
in western Germany fell for the first time in ten years, by 89,000 persons.
Despite the slowdown, during 1992 the German economy reached a milestone
of sorts. With the addition of eastern German production, Germany's GDP
rose for the first time above DM3 trillion. Of that total, the new Länder
contributed a gross regional product of DM231 billion, or 7.7 percent.
However, the total of German unemployed also reached a record number,
4 million. Two-thirds of that number were unemployed in western Germany;
the other one-third were unemployed in eastern Germany. Eastern Germany
contributed more to unemployment than to production.
The 1992 depression continued into 1993, so that the economy actually
registered a negative growth rate of -1.2 percent. By 1994, however, after
the Bundesbank had been lowering short-term interest rates for over a
year, German growth resumed at an annual rate of about 2.4 percent, but
unemployment declined only very slowly despite the uptrend in GDP growth.
It was expected that stronger growth would begin reducing the numbers
of unemployed by 1995 and that Germany would return to its postwar path
toward prosperity. But the absorption of eastern Germany, and the methods
by which it had been accomplished, had exacted a high price throughout
all of Germany.
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