Thayer Watkins
Silicon Valley
& Tornado Alley

The Economics of the
Unification of Germany

Unification was not the real issue with respect to Germany in the post-World War II period. The Germany that came into being in 1871 was an artificial creation of Prussian political maneuvering. It did not include all of the German-speaking areas of central Europe. Specifically it excluded Austria because Prussia saw Austria as a too powerful competitor for Prussian domination of a German state. Germany, Austria and the German-speaking areas of Switzerland functioned quite well as separate political entities and will do so in the future. As long as there is relatively free travel and trade between them there is no need or reason for the German-speaking areas of Europe to be unified. There would be no more need for all of the parts of the German-state Otto von Bismarck put together in 1871 than there is for the unification of the Scandinavian states or the unification of the United States and Canada.

Had East Germany (the German Democratic Republic) been a rational democratic state with a modern economic system there would have been no significant difference between living standards there and those in West Germany (the Federal Republic of Germany). With no significant differences in the quality of life there would have been no need for military control of the border and people would have been able to travel back and forth freely. But the German Democratic Republic (GDR) was not a modern democratic state; it was, at best, industrial feudalism with the people treated as serfs if not industrial slaves. Note that work-avoidance is just as much a characteristic of slave communities as the excess working of slaves; they are just parts of the package of involuntary servitude.

The real problem then was the extinction of the GDR and the only feasible means of achieving that was its merger with the Federal Republic, West Germany. That merger was not as simple and painless as the Germans thought it would be.

Above all it has been costly. West Germany was generous, perhaps overly generous, toward the East Germans in the first few years after unification. The subsidies are continuing nearly fifteen years after unification. In recent years the subsidies have amounted to the equivalent of $110 billion per year. Yet the discrepancies in living standards have not been erased. The former Communist Party has morphed itself into a social democratic party and commands the support of about 30 percent of the voters in the New Lander, the states which were part of East Germany. When East Germany collapsed and an East Germany communist leader said, "We will do better next time," everyone scoffed. With the electoral success of the former communists not everyone is still scoffing.

The East German political system was an abomination. It was unproductive in part because such a high proportion of its population and resources were devoted to policing the rest of the population. One technique for controling the population surprised and shocked the West when it was revealed. State Security maintained an archive of samples of body odors of people who were thought to be security risks. When some political incident occurred such as the posting of a political wall poster the security police would take German Shepherd dogs to the scene to pick up a scent. The dogs would then be taken to the warehouse archives of the body odor samples were kept. The police would select a set of samples of those they thought might have been the perpetrators of the so-called crime. If the dogs indicated that there was a match among the set with the scent from the crime scene then the police would arrest the culprits, who would be mystified as to how the police was able to identify them.

The waste of resources and the moral crimes of the security police were less of a problem for unification than the wrong-headed economic policies the government. The planned economy built manufacturing plants that could not survive without subsidies. The government provided those subsidies but no more than necessary for their survival. The state-owned enterprises then suffered from a shortage of modern equipment. The plants were overstaffed adding to their financial problems. The plants coped with their inefficiencies by neglecting or refusing to abide by reasonable environmental policies. Pollution became endemic. The central planners coped with the lack of productivity by holding down workers pay and by restricting the resources devoted to producing consumer goods. The net result was a system in which the government pretended to pay workers and the workers pretended to work. Decades of government socialistic rhetoric destroyed not only the spirit of entrepreneurship but also the value of self-reliance for major elements of the population.

Although the uneconomic nature of the industrial system and the work ethic promoted by the East German ideology were the major source of the difficulties of unification they were not the only source. The West German government granted a conversion rate of one Deutsche for every East German mark up to a limit of 4000 marks per person and at a conversion rate of one Deutsche mark for every two East German marks for funds above that level. This was a drastic overvaluation of the East German currency. It was intended as a transfer of buying power to the East Germans. But in addition to being an income transfer theconversion scheme administratively set the wage levels for East German workers in the united Germany at one-to-one ratio. It set the wage levels without any consideration of productivities and training. If the wage levels were allowed to be set by supply and demand those factors would have been taken into account. The administratively setting of wages is simply a variety of price controls. One lesson economics has learned but government policy makers have not is that price controls produce chronic shortages. If the price controls are for product prices they produce shortages of goods and services. If the price controls are for wages they produce shortages of jobs. The Federal Republic's policy concerning currency conversion ended up pricing East German labor out of the market. Instead of removing the wage controls the Federal Republic sent in funds for subsidies and social welfare programs. This was a very costly policy mistake.

Chronology of Reunification

(To be continued.)

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