The night that changed Europe
Like most Germans of my generation, I will never forget that night 30 years ago. While working late in my office in Kiel (West Germany) on 9 November 1989, two friends alerted me to news that sounded too good to be true. At midnight, I ended up at the border in Lübeck-Schlutup, greeting East Germans crossing the now open Iron Curtain in their “Trabi” cars. With their courage, East Germans had staged a revolution.
That the wall fell in that particular night was a bit of an accident, arguably the most positive example of the administrative incompetence of East German socialism. But the East German system of repression and its command economy had started to crumble well before. To their credit, the East German communists, who had denied basic freedoms to 17 million people for 40 years and had caged them in with a deadly wall since 1961, finally bowed out without firing a shot in the end. No Tiananmen Square on Alexanderplatz.
In political terms, German unification within a firm European framework has been an outstanding success. Eleven months after the wall came down, Germany (and Europe) were re-united under the reign of democracy and the rule of law. Germany today is a mature country more at ease with itself and its neighbours than ever before.
In economic terms, the ride was rough. Across much of East Germany, mass unemployment that peaked at 18.7% in 2005 and dramatic economic and social dislocations with few peacetime precedents have left deep scars. Over time, however, German unification has turned into a visible economic success as well:
 | Disposable incomes in East Germany have risen to 85% of the West German level. Adjusted for differences in housing rents and other local costs, the East-West gap in living standards has apparently narrowed to less than 10%. Relative to regional differences elsewhere in the world, that is very modest. |
| Much of what used to be East Germany looks beautiful today. The once crumbling inner cities have been largely restored to their previous splendour and the rotting infrastructure has been brought up to a high standard. The often toxic pollution which socialism had left behind has been mostly cleaned up. |
| Despite the heavy costs of transformation, including West-East transfers of some €1.5trn, the united Germany today enjoys virtual full employment, price stability and a small fiscal surplus. |
| In many respects, the old East-West divide is becoming ever less visible. Like the West, the East contains many thriving urban areas including Leipzig, now arguably an even more exciting place than Berlin, London or Barcelona. Today, the real divide within Germany is more between such urban centres and the “left behind” regions with a declining population rather than between East and West. |
| Having learnt from its history, Germany has anchored itself firmly in Europe. During the euro crisis, it felt confident and strong enough to offer serious help to struggling neighbours. In Europe, Germany today is almost always part of the solution, not part of the problem as it had often been in previous centuries. |
The pains of transition
In 1990, the pan-German desire to raise East German living standards fast for reasons of fairness and to prevent mass migration across the now open border collided with economic reality.
Shortly after the wall fell, I had calculated on the basis of some very tentative data that East German productivity was a mere third of the West German level. As it turned out, even that was overly optimistic. In the economic chaos of transition, East German wage costs surged in 1990. With a 1:1 conversion rate chosen for East German prices and wages upon replacing the Ostmark with the West German DMark in mid-1990, East German wage levels were suddenly twice as high as local productivity would have permitted. (While a proposal I had presented in early 1990 to choose a 2:1 conversion rate was initially taken up by the Bundesbank, chancellor Helmut Kohl rejected it for obvious political reasons). The huge real revaluation rendered East German industry even more uncompetitive than it was anyway. The ensuing collapse of industry and plunge in employment made the economic transition more traumatic and disruptive than in the similarly structured Czech lands. It also fuelled the westward move of more than 1.2 million people (net) in the years from 1990 to 2011.
The decision to heavily subsidise living standards in East Germany was the right one. However, it was done in a costly way by raising wages to be paid by places of production that could not afford. Local production and employment would have fallen by less if living standards had been lifted by topping up wages and other incomes for East Germans through direct subsidies. But that is now history.
While the costs of the collapse of East German production became apparent by 1992, Germany did not deal decisively with the fallout for more than a decade. By the late 1990s, it had become the "sick man of Europe", as I labelled the country of "Reformstau" and "Standortflucht" in a research report in early 1998. Only in 2003 did Germany finally grasp the nettle of reforms. Germany made its labour market significantly more flexible and adjusted welfare, unemployment and pension benefits to what it could afford. As a result, the country started to enjoy a “golden decade” once it had emerged from the external shock of the 2008/2009 financial crisis.
Lessons for today
The German experience holds clear lessons.
| 1. | If society wants to raise the incomes of its weaker members, as (West) Germany rightly wanted for its East German newcomers in 1990, it should do so through direct subsidies which do not increase the costs of production. Adding to wage and non-wage costs beyond what companies can afford harms the economy. It ultimately reduces living standards. |
| 2. | Putting off economic reforms, as Germany did from 1993 to 2003, only makes matters worse. In continental European countries with restricted labour market flexibility, labour market reforms are the key ingredient needed for any economic turnaround. Stepping up infrastructure spending, such as Germany had done on a massive scale in East Germany after 1990, can generate huge benefits over time. But it is not the essential element to get business investment and jobs growth going. Extra spending is no substitute for pro-growth reforms. Under the pressure of the euro crisis, Spain, Portugal and Greece have by and large heeded this lesson in the last eight years, France has started to follow suit five years ago. |
| 3. | A well-regulated market economy works, socialism does not. Those who want to combat rising housing rents in German cities today by ever tighter caps on rents or even outright expropriations instead of raising the supply of houses and supporting low-income tenants would do well to remember this lesson. |
| 4. | Geography and regional policies matter. Demographic change needs to be managed to minimise the feeling of “left behind” in regions with a declining population. For example, more investment into the regional transport infrastructure to extend the commuter belt around the thriving urban areas towards more of the outlying and/or de-industrialising regions can yield economic as well as social benefits. It may even help to alleviate the housing shortage afflicting the urban growth areas. |
One generation after the dramatic transformation that liberated all East Germans but disrupted many of their lives, a new discussion has started about the pitfalls and lasting traumas of the shock therapy. Largely due to the legacy of socialism and the dislocations of the post-unification transition period, East Germany today contains a higher share of “left behind” regions with a declining population than West Germany. Partly as a result of this, the right-wing AfD is now twice as strong in the “new Länder” (around 24% in recent elections) than in old West Germany (around 12%). The AfD thrives on anger against supposedly detached “elites”. To some extent, the AfD is turning itself into an East German protest party. It will take a long time until intelligent policies, including regional policies that link the outlying regions more closely to the urban centers, can help to dispel this particular king of discontent.
Thank you
Judging by surveys, people in the East German “Länder” are roughly as happy about their personal circumstances and their personal economic situation today as their counterparts in the West. Political unease in the East seems to be partly fed by a sense that Germany as a whole has not paid enough respect to what East Germans have accomplished under difficult circumstances. In this context, tomorrow’s 30-year anniversary of the fall of the Berlin wall is a great occasion to do so. Beyond acknowledging the disruptions which socialism and its collapse had left in its wake, we should, first and foremost, celebrate the courage of the East Germans who tore down the wall 30 years ago. Let us thank them – and their counterparts in Poland, Hungary and elsewhere – for overcoming the brutal division of Europe in such a peaceful way. Change is rarely painless. But, all in all, the change that started 30 years ago has been decisively for the better.
Holger Schmieding
+44 7771 920377
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