Eastern Germany's economic development revisited: path dependence and economic stagnation before and after reunification

Abstract

Twenty years after reunification Eastern Germany's economy is relatively stagnant compared with most of the productivity and income variables of Western Germany. The strong initial take-off which lasted until the mid to late 1990s ended at a level of 70%–80% of the western reference values. In this article two interdependent hypotheses are put to the test: (i) that the communist economy prior to reunification was on a stagnating path, contrary to what standard analyses show; and (ii) that strong elements of path dependence exist and that the switch from a planned to a market economy offset the pre-unification stagnation but was not able to repair structural deficits inherited from the past. In fact, looking into Western Germany's long-term data, an extremely stable development path can be found that extends from the nineteenth century to the present. Thus analysis of the East German development path is both economically relevant and politically interesting if economic policies are to be formulated. A series for East German output is recalculated to describe the macroeconomic development relative to its West German twin. In doing so, assumptions are made about its initial starting point after World War II and the effects which the deterioration of product quality over time, the loss of international competitiveness and the unavailability of foreign goods had on purchasing power. In fact, performance was very bleak and growth halted in the 1970s. This coincides with fundamental changes in the world economy, the confiscation of the remaining parts of the private sector and ever-expanding subsidisation of private consumption. This led, in sharp contrast to findings by other authors, to a decline in real output until the mid 1980s, when fresh money was brought in from the West. In the end, East Germany collapsed at an economic level comparable to that of West Germany in the mid 1950s to early 1960s, depending on whether the external value of goods or internal purchasing power is used as a reference point. In spite of overcoming its low initial starting position during the first years after transition to a market economy began, Eastern Germany has reverted to its old development path extending from the 1950s and the 1960s.