Eastern Germany in the fifth year – Investment hammering in the basement?

Rebuilding the capital stock will play the decisive role in the adjustment process in the eastern German economy. Investment increased from DM 92 billion in 1991 to 157 billion in 1994 (in current prices). It amounted to 60 percent of GDP. Investment has been heavily concentrated in buildings; only one-third has gone to machinery and equipment. Less than 20 percent of investments have gone to industry. Using back-of-the envelope calculations, it is shown that eastern Germany still needs a massive capital accumulation in the years to come, more than DM 1 trillion in the enterprise sector. In addition, the housing sector and infrastructure will require sizeable investment. In the adjustment process in the eastern German economy, the J-curve of transition with respect to production and the u-curve with respect to employment are becoming evident. Because transfers have stimulated the nontradables sector, a Dutch-disease phenomenon has been superimposed on the transformation problem. The production of nontradables in some sectors has doubled since the second half of 1990, as, for instance, in construction and in construction-related industries. However, in the tradables sector, especially in the capital goods sector, the 1990 production level has not yet been reached. An export basis has not yet been developed. With respect to GDP, the catching-up process has taken place with remarkable speed. GDP per capita (in current prices) rose from 31 percent of the western German level in 1991 to 47.9 percent in 1994. This implies a convergence rate of roughly 6-7 percent per year, which is by far higher than the Barro rule of 2 percent. Assuming a target of 80 percent of the western German GDP per capita level, the growth gap for alternative growth differentials between eastern and western Germany is calculated. If eastern Germany had a growth advantage of 5 percent, it would reach 80 percent of the western German GDP per capita level in 2004. If west Berlin is included in eastern Germany, the target is reached two years earlier. Economic policy for eastern Germany will have to return to normality in the future, treating eastern Germany as just any other region in Germany. Transfers will have to be reduced. The excess of absorptive consumption over domestic production will have to be reduced and the difference between the trade deficit and gross investment will also have to be reduced. Whereas eastern Germany seems to be moving in the right direction, German unification has drastically disturbed the macroeconomic policy mix between fiscal policy, wage policy and monetary policy, and Germany will be occupied for some time in trying to find a sustainable steady-state position in that policy mix.