On July 2, 1990, the East and West Germanies economies became one as part of the process of German reunification. It was the first time in history that a capitalist and a socialist economy had been joined together, and there were no precise guidelines on how it could be done. The comparatively poor productivity of the former East German economy and its links to the economies of the Soviet Union and Eastern Europe, which were rapidly contracting, posed pressing issues for the new united German government.
Even before economic unification, the West German government had decided that one of its first tasks was to privatize the East German economy. For this reason, it had taken over the Treuhandanstalt (Trust Agency, commonly known as Treuhand), which had been established by the GDR to take over East German firms and turn them over to new management through privatization, in June 1990. The agency assumed the assets and liabilities of about 8,000 East German enterprises in order to sell them to German and other bidders. The CEO of Treuhand, Detlev Karsten Rohwedder, was assassinated by far left terrorist organization Red Army Faction in Düsseldorf in 1991; by the time the Treuhand was disbanded at the end of 1994, it had privatized some 14,000 enterprises.
Initial challenges As economic unification proceeded, issues that had been recognized but inadequately understood in advance began to surface. There was massive confusion about property rights. As wave after wave of Nazi, Soviet, and later East German expropriations had taken place between 1933 and 1989, there was often little knowledge of the original ownership of property. More than 2 million claims on properties in the territory of the former East Germany (GDR) were filed by the December 31, 1992, deadline. As more claimants emerged, with many winning cases in the courts, potential investors were often scared off.
Another problem was that East German production costs had been very high. The conversion rates of the GDR mark to the Deutsche Mark often kept those costs high, as did the early wage negotiations, which resulted in wages far above the productivity level. Western German firms found it easier and cheaper to serve their new eastern German markets by expanding production in western facilities.
A third problem was that the inadequate infrastructure also became a problem for many potential investors. The telephone service was improved only very slowly. Many investors also complained about energy shortages, as many East German power stations were shut down for safety and other reasons. Roads and railroads, especially the Nazi-era Autobahns had to be virtually rebuilt because they had been so badly maintained.
In addition to these practical problems, there was also a deep policy dilemma that underlay the entire process of unification. From the beginning, there had been a pernicious link between the earlier and later phases of the East German transition to a free-market economy. Policies calculated to make the initial adjustment as painless as possible hampered long-run growth and prosperity. Real economic efficiency could only be achieved by permitting and even forcing considerable immediate dislocations, whereas temporary compromises might lead to permanent structural burdens. However, excessive disruptions could jeopardize the economic and political stability required for a smooth unification process and might also cause streams of East Germans to move west. The government was never able to solve this dilemma. When it was forced to choose, it usually selected the more expensive and slower course to encourage people to stay in the east.
Welfare state issues The merging of the former GDR Eastern States, also known as the New Länder, with West Germany's market produced significant economic pressure on the German welfare stateGreen, Simon, et al. The Politics of the New Germany. London and New York: 2012. pg 156;159 Print. Germany's conservative model welfare state was sustainable under the economic conditions of pre-unification but had trouble accommodating the increased costs associated with the integration of infrastructure, migration and labor of the New Länder.Angresano, James. “THE CONTEMPORARY WELFARE STATE: THE ISSUE OF SUSTAINABILITY.” French Welfare State Reform: Idealism versus Swedish, New Zealand and Dutch Pragmatism, Anthem Press, LONDON; NEW YORK; DELHI, 2007, pp. 1–38, www.jstor.org/stable/j.ctt1gxpcmb.5.Padgett, Stephen, et al. Developments in German Politics. Palgrave Macmillan: New York. 2012. pg 229 Print.Green, Simon, et al. The Politics of the New Germany. London and New York: 2012. pg 10 Print. The social welfare programs offered, i.e. state pensions, unemployment insurance, traditionally adhered to a means testing and an earnings related basis for recipients, which had the potential to be more generous where permitted.Bowman, John. “Capitalisms Compared: Welfare, Work, and Business.” Sage Press. 2014. pp 8; 15-17Green, Simon, et al. The Politics of the New Germany. London and New York: 2012. Print. 155;159 These expenditures are publicly financed, by the collective taxation of wage-earning employees and employers.Green, Simon, et al. The Politics of the New Germany. London and New York: 2012. pg. 157 Print. This system requires a labor market characterized by high productivity and high employment to mitigate taxation and claims per capita for sustainability, both of which the new Länder lacked.Burda, Michael C., and Jennifer Hunt. “From Reunification to Economic Integration: Productivity and the Labor Market in Eastern Germany.” Brookings Papers on Economic Activity, vol. 2001, no. 2, 2001, pp. 24-27
Unemployment Insurance Workers contribute a portion of their income via taxation and employers match workers' contributions, where the sum is stored in a national pool that immediately reallocates funds to pay existing claims.Green, Simon, et al. The Politics of the New Germany. London and New York: 2012. pg. 157-159 Print. There was an East-West productivity gap, attributed to poor labor market performance which was caused by high unemployment and lesser skilled labor in the New Länder relative to the West, increasing the demand for benefits and decreasing relative contributions for social welfare benefits.Grossmann, Volker. “Skilled Labor Reallocation, Wage Inequality, and Unskilled Unemployment.” Journal of Institutional and Theoretical Economics (JITE) / Zeitschrift Für Die Gesamte Staatswissenschaft, vol. 156, no. 3, 2000, pp. 473-475; 478, 500. The expanded coverage of welfare policies to the New Länder permitted an exponential increase in the number of claims and beneficiaries nationwide.Padgett, Stephen, et al. Developments in German Politics. Palgrave Macmillan: New York. 2012. pg 133; 148 The disproportionately productive West had to compensate for the lack of taxed contributions, in addition to the influx in claims, from the less productive New Länder.Green, Simon, et al. The Politics of the New Germany. London and New York: 2012. Print.Lenk, Thomas, and Volkmar Teichmann. “The Significance of Public Transfers for Absorbing Social Shock during Transformation in the New German States.” The European Journal of Social Quality, vol. 1, no. 1/2, 1999, pp. 147-149; 152; 163
Costs Increasing costs pressured reformation of the welfare expenditures.Padgett, Stephen, et al. Developments in German Politics. Palgrave Macmillan: New York. 2012. 133-134 The growth in welfare costs was compounded by a decline in the contributor/beneficiary ratio: by the mid-1990s, the unemployment rate was about twice as high in the New Länder than it was in the west and the number of welfare beneficiaries had outgrown the number of wage-earning employees nationwide.Padgett, Stephen, et al. Developments in German Politics. Palgrave Macmillan: New York. 2012. pg 236 Print. Into the early 2000s, social welfare accounted for most costly portion of public expenditure: about 32% of national GDP and 50% of GDP in the New Länder.Padgett, Stephen, et al. Developments in German Politics. Palgrave Macmillan: New York. 2012. pgs 236-238Burda, Michael C., and Jennifer Hunt. “From Reunification to Economic Integration: Productivity and the Labor Market in Eastern Germany.” Brookings Papers on Economic Activity, vol. 2001, no. 2, 2001, pp. 1–3; 5, 7 www.jstor.org/stable/1209133.Copy. web. This contributed to Germany breaking deficit thresholds of the Stability and Growth Pact.Headey, Bruce, and Derek Headey. “German Reunification: Welfare Gains and Losses East and West.” Social Indicators Research, vol. 64, no. 1, 2003, pp. 107-111, 122, 137Padgett, Stephen, et al. Developments in German Politics. Palgrave Macmillan: New York. 2012. pg 133-135, 137
Privatization and private investment
Despite these problems, the process of unification moved ahead, albeit slowly. The Treuhand, staffed almost entirely by Germans from the west, became the virtual government of eastern Germany. In the course of privatization, the agency decided which companies would live and which would die, which communities would thrive and which would shrivel, and which eastern Länder would be prosperous and which would not. It also decided who might or might not buy eastern firms or services.
Whether correct or not, reports persisted throughout the first years of unification that foreign enterprises were being screened more carefully and more skeptically than German firms even as they were being invited to invest. Less than 5% of all investment in eastern Germany was non-German, and most of that was from companies with subsidiaries in western Germany who were expanding them to the east. The Japanese did not invest, although they had previously expressed some interest, and the offices the Treuhand established in New York and Tokyo found few investors.
The economy of eastern Germany went into a deep and precipitous slump immediately after unification. Within a year after unification, the number of unemployed rose above 3 million. Industrial production in eastern Germany fell to less than half the previous rate, and the total regional product fell precipitously through 1991. One estimate was that in 1991 the entire production of eastern Germany amounted to less than 8% of that of western Germany.
Because the process of unification was managed by persons from western Germany, new eastern firms were usually subsidiaries of western firms, and they followed the western ownership and management patterns. Bank participation became customary, especially because the large Frankfurt banks assumed the assets of the former East German State Bank, and most eastern firms thus owed money to those Frankfurt banks. The banks installed their representatives on the boards of the new firms and assumed some supervisory functions—either directly or through control by western firms with bank representation. The Treuhand had close contacts with western German banks. Many of its employees came from those banks and planned to return to their jobs at the banks.Ghaussy and Schäfer,The Economics of German unification (1993) p 187