Economically, reunification has been devastating for the east. It need not have been.
Two decades after the fall of the Berlin Wall, West German politicians look on with satisfaction at the results of 20 years of reconstructing East Germany. East German town centers have been beautifully restored, prefabricated socialist buildings widely refurbished, highways expanded and upgraded. The social welfare network is tightly woven while unemployment benefits include paid vacation.
At first glance, East Germany seems far ahead of its neighboring countries of Poland and the Czech Republic, whose economy also underwent a transformation from a socialist planned economy to a market-driven one. But a bitter truth remains, although unspoken: While the economies of Poland and the Czech Republic, Hungary and Slovakia have managed to get on their own feet, East Germany is still fed intravenously by its western half. East Germans consume more than they produce, a gap of at least 20%. The East German economy is anything but self-supporting.
This failure is taboo to speak of. The admission is especially hard to stomach as financial aid from West Germany has been more than generous: €1.3 trillion ($1.9 trillion) since 1990.
Why have the effects of West German financial aid been so limited?
One of the most important reasons for the current plight was the monetary union. Based purely on political considerations, the West German government in 1990 valued the eastern mark at half of the West German mark, a ratio of two to one. For wages an even higher ratio of 1-to-1 was set. As it turned out, this was an overvaluation of over 500%. The black market going rate at the time of 10-to-1 was more realistic. The negative repercussions as a result of the generosity of the West German government were soon felt. Although workers’ savings were only reduced by half, effective labor costs skyrocketed. East Germany priced itself out of the marketplace. The Soviet zone soon turned into a de-industrialized zone. While workers got to keep their savings accounts, they lost their jobs. Despite herculean efforts over the next 19 years, East Germany never recovered from this initial shock. Today 95% of all businesses in East Germany have less than 50 employees.
Also from purely populist motives, the path to wage equalization was rashly paved, with West German unions playing a disreputable role. Despite low productivity, wages were raised. This was not all: Regulations included a 40-hour work week, a ban on Saturday work and overtime limits. On top of this were lavish perks that ranged from sick pay and vacation allowance to weeks-long spa visits.
For East German companies that already had trouble repaying the loans taken out to buy new equipment and fixtures, their situation often became financially intolerable. Moreover, new regulations regarding workers’ right to participate in decision making, particularly in terms of refurbishment and restructuring, added to the woes.
Flying the banner of equality, the disastrous strategy of the unions continues until today. Just a few weeks ago, the steel workers’ union celebrated that “the 35-hour week has now reached the east.” Today no more than 8,000 steel workers are the beneficiaries, when at the start of wage equalization there were 60,000.
The unavoidable loss of jobs was however not dealt with by greater flexibility but through expensive state spending programs: job creation schemes, a publicly financed employment sector and training measures. They had one thing in common: All of these programs neglected businesses’ real needs. The results were therefore limited, to put it mildly. Just 4% of participants in state-financed job-creation programs found employment afterwards.
The conclusion after many years of state-financed employment assistance is apparent. No measure, no matter how good, can replace work experience in an actual firm. Wage subsidies to employers have proved to be most effective. When job-creation schemes turned out to produce little effect, cities and towns took a different approach: The public sector began to take on ever-increasing numbers of employees themselves. The consequence today is overstaffed state offices and budget deficits. At the same time, problems have intensified the tension between the employment market and the social-welfare system. There is a disincentive for people to work a 40-hour week if the wages they earn are only slightly higher than the unemployment benefits they would receive for doing little or nothing.
What’s more, after reunification, with a few exceptions, West German law was extended to the eastern part. Like a net, laws, regulations and policies were cast over East German companies. Company law, business law and accountancy law were not only unfamiliar but had been tailored to West Germany’s highly sophisticated economy. What might have been a handicap for a competitive West German company often became a stranglehold for East German companies.
Today, what had been achieved in 20 years of “Aufbau Ost” (building the East) is under threat. Due to their low wage costs—only 25 % of those in Germany—flexible labor regulations and weak currencies, Central European companies soon became competitors of East German firms after 1990. Most attractive for West German investment have been Poland, the Czech Republic and Slovakia. Nearly all major German firms have not only established offices there but production plants as well: Volkswagen, Beiersdorf, MAN, Siemens, to name a few. Their main market still remained West Germany.
The competitiveness of Central and East European countries continues to improve. Up to now, they have been competitors in the construction and trade sectors, but they are increasingly vying for business in the mechanical-engineering and engineering-services sectors.
The new rivals from the East, not to mention global competition, now threaten all that has been achieved in East Germany. This includes the shipbuilding industry, which has undergone arduous years of restructuring. The same goes for certain sections of the car and car supplier industries, the solar industry as well as the chip and IT industry.
The German reunification was politically a great stroke of luck. West Germany has however not taken full advantage afforded by the event to make necessary reforms to revamp its antiquated welfare system.
The German government has not been able to reform the welfare state. This is especially surprising given that the high level of social welfare benefits in Germany came about partly as a result of the propaganda war between East and West during the Cold War. Each side was determined to show its population that they were better off than the people on the other side of the wall. The two governments ignored the economic consequences of creating such unaffordable welfare systems. And after reunification, the social welfare system was neither remodeled in West Germany nor reconceived in East Germany.
Without sweeping reforms in the whole of Germany, East Germany will not only stagnate but will slide ever further behind economically. There is much to celebrate about the reunification of Germany. But economically, it has been a disaster for the East. And more than €1 trillion later, the costs of those policy errors is being paid in the west as well.
Mr. Hummel is deputy director of the State Ministry of Finance for Berlin.