The lesson of West Germany & GDR

Strangely enough, Germany seems intent on ignoring the best lesson on the North/South problem within the Eurozone – its own experience with the former GDR after unification.

Estimates of the cost of German unification during the last 2 decades range between 1.500-1.800 MEUR. The privatization of the GDRs industrial sector (about 8.000 companies) was initially projected to generate revenues of about 600 billion Deutsche Mark and ended up causing losses of 250 billion Deutsche Mark. What went wrong?

On July 1, 1990 (even before the official unification), the GDR Mark was exchanged into Deutsche Mark at rates between 1:1 to 2:1. This was a political decision; many economists (above all the Bundesbank) urged not to do that. The government under Helmut Kohl argued that there was no alternative to doing that lest there not be a massive migration from East to West.

The net result was that the GDR economy was overnight catapulted into international competition. Liabilities were now in strong currency as were asset values, except that liabilities are seldom less than the books show and GDR asset values were already before the conversion less than the books showed.

In addition to these devastating financial consequences, the West German corporate sector had absolutely no interest in supporting the build-up of a real competitor in the East and they were supported in that by the unions who preferred keeping jobs in the West. Not only did the West German corporate sector not offer any help to the East but they even talked those GDR companies which could have competed with them even in hard currency down. To top it off, they showed no interest in investing in the GDR and preferred exporting to the GDR from the West. Since the overvalued and non-competitive East was eventually out of an industry of its own, the East became totally dependent on transfer payments from the West.

Within a few years, West Germans were making noises behind closed doors that perhaps the Wall should be built again. Why? Because they saw on their tax returns how much the unification was costing them (an 8% surcharge on income taxes payable otherwise).

So Germany then learned the lesson which is so important that it is again learned today: one can’t have both, have the cake and eat it at the same time. One either supports a region to develop a value-generating economy on its own (which means lesser exports to that region) or, if not, one can continue to export but then one has to make transfer payments so that this region can pay for the exports.

There isn’t really another way!