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German Reunification

Germany's east still lags behind

Germany's former-communist eastern states have caught up in many areas - except productivity, which still languishes at stubbornly low levels. Time could fix that, but time is one thing the east doesn't have.

The sheer dimensions of the migration that followed the fall of the Berlin Wall on November 9,1989 were staggering. Four hundred thousand people had crossed over from East to West by the time Germany reunified just under a year later. It was a real exodus from the former Communist German Democratic Republic.

At the time, Chancellor Helmut Kohl was under great pressure. A mere three months after the Wall came down, he announced the establishment of a monetary union to begin on July 1, 1990.

East Germans would get to replace their near-worthless ostmarks with West Germany's deutschmarks - an incentive for people to stay where they were. Unified Germany is still paying for that concession today.

On February 9, 1990, the advisory council tasked with assessing economic development wrote a letter asking him to commit to economic reforms first. "We believe the rapid realization of a monetary union is the wrong way to stem the flow of emigrants."

The end of competitiveness

But Kohl disregarded the economists' warnings and on July 1, wages, salaries and pensions were paid out in hard-currency deutschmarks at a rate of one-to-one.

But the one-to-one exchange ratio failed to reflect actual productivity in the two economies. At the end of the East German dictatorship, productivity had reached only one-third of West German levels. The exchange rate caused prices in the east to skyrocket.

If this hadn't been bad enough, eastern German firms lost their ability to compete on the free market once and for all following unification. In early 1991, unions and employers based in the west began negotiating eastern German wage levels.

In so doing, they imposed western German pay scales, from a country that had enjoyed 40 years of growth and ever-increasing productivity - on the remnants of a collapsed command economy.

The result was rapid wage increases - followed by bankruptcies and unemployment. "Wages were advancing faster than productivity levels," said Gerhard Heimpold from Germany's Halle Institute for Economic Research. "That meant companies couldn't afford them."

This massive deindustrialization process cost more than 1 million jobs, Heimpold estimates. Unemployment in the eastern states climed to 17.7 percent by 1997. Many young and well-educated eastern Germans headed west. In 2005, joblessness in the east reached a peak of 18.8 percent.

The long-promised blossoming landscapes

It wasn't until 2006 that things began to shift course and unemployment receded. In 2013, the unemployment rate hit its lowest level since 1991 at 10.3 percent. The difference between east and west became increasingly blurred.

The former East German state of Thuringia is in better financial shape than western Germany's industrial heartland of North Rhine-Westphalia or its city-state of Bremen. And some cities in the east have unemployment rates between 4 and 6 percent that are otherwise only found in the prosperous southern states of Bavaria and Baden-Württemberg.

On paper, at least, eastern Germany's most impressive growth period came in the first five years after the Wall fell. There was a sizeable backlog of investments for the housing market, infrastructure and companies, areas bankrupt East Germany had long neglected.

Until the mid-1990s, the east's gross monetary product (GDP) grew at a rate comparable to West Germany's post-WWII economic miracle - and at a much higher output level. But this was due largely to government transfer payments, not private investment.

According to calculations from the Ifo Institute in Dresden, the tally of financial transfers from the west reached 560 billion euros ($701.1 billion) between 1991 and 2023. "That was money well spent," Heimpold said. Today, the manufacturing sector in eastern Germany is better capitalized than in western Germany. Plus, the infrastructure is more modern, the historic cities have been restored and the universities are well equipped.

Structural problems still bog down the East

But the measure by which Germany's second economic miracle judges itself makes economists uncomfortable. After all, stagnation often follows initial growth. Big investment targets are a thing of the past. For the last 20 years, eastern and western German economic figures have failed to align.

The collective GDP of Germany's eastern states has only managed to reach 67 percent of that in western states. The east does not need to reach 100 percent of GDP levels in the west, said Klaus-Heiner Röhl from the Cologne Institute for Economic Research. "But 67 percent is pretty low." Even the poorest western state, Schleswig-Holstein, is at 82 percent.

"We are facing a demographic shift," Heimpold said. "The prosperity of the region and the country will depend on a decreasing number of workers." But that's incredibly difficult, because the consequences of economic policy in the monetary union have grown into today's structural problems.

The eastern states never really recovered from the harsh deindustrialization in that early phase. Mid-sized companies form the backbone. "When we look at companies with 100 to 250 employees and then compare this class of company between east and west, then we find that they are roughly equal economically," Röhl said. Even so, eastern German productivity has only reached three-quarters of that in the west.

The key to success: more innovation

What the east really needs is big companies. They're mostly based in the west, and they make all the difference. And they're not only more productive on average, they export more and are therefore have the capacity to grow faster.

The export rate in western Germany is 50 percent - in the east it is a bit over 30 percent. Big companies typically invest more in research and development, and are thus more innovative and competitive. In the west, the private sector is responsible for about 70 percent of the amount spent on research and development - in the east it's only 40 percent.

That is not to say that small and medium-sized companies in the east can't blossom into big companies. But that takes time.

But time is one luxury eastern Germany simply does not have. The region is running out of working-age residents. Well-qualified young people are leaving their hometowns behind, and this migration has only exacerbated the shortage.

Between 1990 and 2012, the number of working people decreased from 11.2 million to 10.1 million. In western Germany, that number remained roughly stable. By 2030, the number of people in work is expected to drop by millions. Ifo's Joachim Ragnitz fears a shortage of labor and even lower growth. "The continued convergence of living standards could then even begin to falter," he said.

The only thing to be done against this demographic development, Röhl said, is to make all processes more efficient, more knowledge-based and more innovative. That could help counter "a kind of lethargy that may set in."

It's a Herculean task for a middle class. But if it succeeds, Germany could look forward to a pleasant German-German fusion. If it succeeds.

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