German Unification: Economic Problems and Consequences

Economic unification forced an unprecedented adjustment crisis on the East German economy. The revolutionary shock of the transformation of the economic order was reinforced by a real appreciation shock exceeding 50%, due to the immediate introduction of the Deutschmark. This paper examines in detail the real and monetary consequences of unification. It is shown that the currency conversion created (by means of an excessive money endowment) a potential for price level rise of between 3.7% and 6.6% for 1991. With industrial production down by 50% and effective unemployment exceeding 20%, large-scale public transfers from West to East Germany are unavoidable. The 1991 transfers are estimated to reach 73% (6%) of East (West) German GNP. Most of this will finance consumption. The paper also estimates the capital gap. With about 70% of the East German capital stock obsolete, the maximum gap is DM 1.8 trillion. The actual gap and the resulting adjustment load on the global saving-investment balance are likely to be much smaller. A major conclusion is that speeding up the process of enterprise privatization is the most pressing issue. While it is important to eliminate the potential for inflation by redressing money growth, rapid privatization of the thousands of state enterprises is the key to reshaping East Germany from the supply side. By promoting the reallocation of East German capital and labour, a more rapid privatization will lead to large efficiency gains and will reduce the time taken for the East German region to catch up.