The Evolving German Economy: Unification, the Social Market, European and Global Integration

Abstract

The Evolving German Economy: Unification, the Social Market, European and Global Integration Norbert Walter (bio) At the start of the nineties, many believed —particularly in America— that the coming decade would be the decade of the Germans. The changes accompanying the end of the Cold War seemed to favor Germany the most among the western countries. German unification, which had long seemed a pipe dream, became a reality. As a result, what was already the most important economy in Europe, increased in size by approximately 40 percent and in terms of labor potential and consumers by more than 25 percent. Furthermore, Germany had moved overnight from the periphery of what was western Europe to the heart of what had become continental Europe. Geography, tradition and economic strength suggested that Germany would become the most important western partner in reforming the states of eastern Europe, which were endeavoring to rebuild their economies and integrate them into the world economy. There were also high hopes that Germany, especially East Germany, would become the West’s bridge to the East. Moreover, the new Germany continued to share in all the opportunities promised by the continuing integration process in western Europe. Germany did in fact start this decade with a boom. While the world economy, above all North America and the United Kingdom, slipped into a recession, Germany in 1990 and 1991 experienced its strongest surge of growth since the beginning of the seventies. The strong demand in East Germany, which was financed by extensive transfers from the western part of the country, made it possible —temporarily— to detach from the global [End Page 55] economy. The unification-induced boom also further concealed West Germany’s latent structural problems. The all too optimistic expectations based on short-term economic performance were, however, quickly followed by the usual cold shower. In East Germany, the difficulties which accompanied the restructuring process were more serious than anticipated. One reason was the collapse of the markets in eastern Europe. A more serious reason was a misguided wage policy. The conversion of wages and salaries in East Germany to a deutsche mark (DM) basis as part of the economic and monetary union in 1990 led to a surge in wage costs. This undermined the ability of less productive East German firms to carve their niche in the market in the years after unification —particularly as the quality of their products did not rise to western standards. Industrial output, for example, is estimated to have slumped some 60 percent between 1990 and 1993. In West Germany, the end of the unification-induced boom triggered a deep crisis in 1992 and 1993. The weakness of the global economy now reached the German economy, late but with full force. The unfavorable exchange rate situation (strong DM) with concurrent high production costs exacerbated the crisis. Fiscal policy was powerless to avert the crisis since funds for further budgetary expansion were missing thanks to the government’s already high transfer payments to the eastern Länder. The problem with fiscal policy was not so much that transfers to East Germany were too high, but that they came on top of the still generous government spending in the western part of the country. The sluggish economy resulted in a shortfall in tax revenue, which meant a strong rise in public sector deficits —from 2.1 percent of the GDP in 1990 to 3.2 percent in 1993. Fiscal policy therefore had to consolidate at the time when it should have expanded to offset the recession. The enormous government deficit, coupled with high wage increases also left monetary policy little room to maneuver. The Bundesbank actually increased interest rates until July 1992 and thereafter only cut key rates in a series of mini steps, less than in earlier recessions. An easing of the tight monetary policy would have induced a sweeping recovery of the [End Page 56] domestic economy. And of course, the relatively high money market rates were one factor behind the deutsche mark’s high valuation, and indeed remain so to this day. The pressure on the German economy to make structural adjustments mounted. Companies had two strategies to rectify their situation: move production...