Economic Consequences of German Reunification

1
Economic Consequences of German Reunification
2
Overview

• German History after 1945
• Policy Strategy for Reunification
• Impacts of Reunification on Germany
• Impacts of Reunification on Europe
• The Situation Today

3
The Potsdam Conference 1945

• President Truman, Premier Stalin, and P.M. Attlee
  meet.
• The intent was to ultimately govern Germany
  together.
• The agreements fell apart soon after they were
  made.
• France did not feel bound because it did not
  participate
• Cold war tensions and vague wording resulted in
  different interpretations

4
Four Occupational Zones

• Germany was subdivided into 4 zones
• Berlin was also divided into 4 similar zones
• The Soviet zone became the German Democratic
  Republic (East Germany)
• French, British, and American zones united to
  form the Federal Republic of Germany (West
  Germany)

5
East Germany
Check Point Charlie

• Established an authoritarian government with a
  centralized command economy.
• Became the wealthiest and most advanced country
  in the Eastern bloc but still well below western
  standards.
• Political freedoms were denied
• Mass defections to the West prompted the
  development of the GDR border system.

Courtesy of Stephen Windsor
From Dornbusch R., H. wolf, and L. Alexander
1992
6
(No Transcript)
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West Germanys Wirtschaftswunder

• West Germany developed a capitalist social
  market economy and a democratic parliamentary
  government.
• Prolonged economic growth fuelled the economic
  miracle of the FRG.
• The economy was primarily built upon industrial
  activities.

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Reunification

• In 1989 Hungary removed border restrictions with
  Austria
• More than 13,000 East Germans escaped to the West
  through Hungary
• Gorbachev pressurized the GDR to accept change.
• In October 1989, the entire East German cabinet
  resigned and travel restrictions were removed.
• Citizens began manually knocking down the wall.

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November 9th, 1989
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The Economic Plan for Unification

• West German industrial efficiency was expected to
  quickly overcome the economic challenges.
• East German currency would be exchanged for West
  German currency at a rate of 11
• East German wages would be raised to Western
  standards immediately.
• Private Debts would not be eliminated.
• Property rights were not clearly defined.

11
East German Firms Could not Compete

• Artificially high wages in the East resulted in
  high unemployment.
• GDP dropped while a thirst for imported goods
  increased.
• Exports remained at low levels.

From Dornbusch R., H. wolf, and L. Alexander
1992
12
The West German Burden

• By 1996, the amount of money absorbed by East
  Germany was 50 larger than the GDP
• 160 billion DM was from public investment
• 75 billion DM was from private investment

From Sinn, H.W.. 1996
13
The West German Public Debt

• East German workers began competing for West
  German jobs
• The unification expenses were funded through
  borrowing rather than tax increases.
• Historically low German debt skyrocketed.

From Dornbusch R., H. wolf, and L. Alexander
1992
14
The EMS

• The European Monetary System (EMS) was designed
  to keep European currency exchange rates within a
  narrow band.
• Germany was the key currency because it had the
  highest GDP. All other currencies tried to match
  German monetary policy.
• This was accomplished by interest rate
  fluctuations and the buying and selling of
  foreign exchange reserves.

15
European Interest Rates

• As investment in East Germany grew, the interest
  rates rose in Germany.
• This caused an interest rate increase reaction
  from the rest of Europe.
• Interest rates in Sweden and Ireland rose as much
  as 500

From Sinn, H.W.. 1996
16
EMS Crisis

• Neighboring European countries raised their
  interest rates in an effort to protect their
  currencies from devaluation.
• Interest levels peaked on Black Wednesday in
  September of 1992.
• In order to keep pace with the rising value of
  the DM, other nations raised interest rates and
  experienced currency devaluations.
• The British pound and Italian lira were
  temporarily suspended at the peak of the crisis.

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The Real Value of the Deutschmark
From Sinn, H.W.. 1996

• The value of the German Deutschmark also
  increased relative to other European Currencies.
• To counteract this devaluation, other countries
  raised interest rates.

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The EMS Crisis
From Sinn, H.W.. 1996
19
Investment Today
From The Spiegel Online, 2005

• Despite trillions of Euros being poured into the
  former East Germany, the GDP has not increased.

20
References
Berg, S., S. Winter, and A. Wassermann. 2005.
The Price of a Failed Reunification. Spiegel
Online International. Sept. 2005. Sinn, H.W..
1996. International Implications for German
Reunification. Brookings Papers on Economic
Activity. 1/1996 pp.1 28. Dornbusch, R., H.
Wolf, and L. Alexander. 1992. Economic
Transition in Eastern Germany. Brookings Papers
on Economic Activity. 1/1992 pp.235
272. Miles D., and A. Scott. 2005.
Macroeconomics and the Global Business
Environment. John Wiley Sons. N.J.
21
The Situation Today
From The Spiegel Online, 2005