East Germany: The Economics of Kinship

Assessments of the East German transition commonly focus narrowly on the size of financial transfers from the West to the East. Of more relevance to other cases of transformation is the fact that East Germany was immediately brought into the trading and financial system of the world economy and immediately adopted Western legal and administrative structures. In doing so, German union has created a unique environment for transformation in East Germany. In this paper, I review the main elements of German union: monetary union, fiscal union, legal and administrative union, and rapid privatization. I then review the main economic developments since 1990. From a macro-economic perspective, unification has promoted East Germany's fast integration into the Western trading and financial system . These factors may help in the longer run to overcome the huge terms-of-trade shock implied by monetary union and the loss of the traditional external markets. On a politico-economic level, German union has created an environment favourable for a big-bang strategy of reform by reducing the distributional problems reform processes may face and that have led to stalemate in the political process in other transition countries. The East German labour market was drawn into the West German pattern of industrial relations, which traditionally have favoured insider-outsider behaviour. The result has been massive destruction of employment. Thus, the most fatal mistake in the unification process was the immediate extension of labour market regulation that favour insider-outsider behaviour to the East.