Thirty years German Reunification - A reason to celebrate but a blueprint for other country mergers?

2019 marks 30 years of the Fall of the Berlin Wall. An anniversary worth celebrating as it is one of the most potent symbols of the Cold War’s demise and the end of many brutal authoritarian systems of the Eastern Bloc. Looking at the economic success and ...

2019 marks 30 years of the Fall of the Berlin Wall. An anniversary worth celebrating as it is one of the most potent symbols of the Cold War’s demise and the end of many brutal authoritarian systems of the Eastern Bloc. Looking at the economic success and the applied public policy during and after Germany’s reunification, some open questions need to be answered. Until now, it is not clear whether it was a textbook ‘merger’ of two economic systems or another policy approach would have lead to faster convergence of both economies. Thirty years later, East Germany does not enjoy more wealth than post-communist countries such as Slovakia or Slovenia.

The East German economy was in shambles and one of the primary reasons for the rapid collapse of the system in 1989. Without loans from its capitalist neighbor, East Germany would have probably already collapsed in the early ’80s. Its competitiveness was only a fraction of West Germany, its industries not functional, and the workforce’s skills behind the international average. Many economists and even the former Minister of Economics Graf Lambsdorff suggested making East Germany into a special economic zone with its labor code, a lean welfare state, and attractive investment conditions. Only by allowing a free market environment would the former planned economy have a chance to become more competitive and eventually catch up with its Western brothers.

An unholy alliance of politics and labor unions killed the idea of a special economic zone quickly. Conservative Chancellor Helmut Kohl promising to his East German voters ‘flourishing landscapes’ and immediate prosperity and West German labor unions being afraid of competition from a more liberal Eastern neighbor pushed for full adoption of West Germany’s sclerotic labor, commercial, and welfare codes overnight and succeeded doing this.

In 1991 a so-called temporary solidarity tax of an additional 5.5% of the capital gains or income tax liability was introduced to fund a massive ‘reconstruction project’ of East Germany. As Milton Friedman would have said, there is nothing more permanent as a temporary government program’ and guess what: The temporary German solidarity tax is still around.

Roughly 2.5 trillion Euros (nearly 3 trillion USD) or close to 200,000 USD per East German resident have been paid in transfer payments from West to East Germany in the past three decades. Leaving East Germany alone would have allowed them to have competitive labor laws. A flexible economy would have gotten them at least to the same wealth levels they are now at thanks to massive subsidies from West Germany’s taxpayers.

In 2018 even including all of these subsidies the states within former East Germany receive, they merely make it to 70% of the West German GDP per capita. The GDP per capita PPP Slovakia in 2017 was 33,025 USD, and thus only 7% below East Germany’s 2017 GDP per capita. Ex-Yugoslav Slovenia ranks even closer to the former Federal Democratic Republic of Germany.

But it gets worse: Without these transfers, demand in East Germany would be 25 percent lower, and estimates suggest that the real economic performance (GDP per capita) would not be 70 percent, but below 60 percent of West German levels and thus rank below former Soviet (sic!) Republics Estonia and Lithuania which did not get any significant help to restart their economies after leaving the iron curtain. Unemployment rates in East Germany went down a lot in the past years but still are 45% higher than in West Germany.

Embedded in the former East, Berlin is one of the few capitals in the world that manages to have a lower GDP than its country's average. If Berlin left Germany, the average GDP would go up - compare this to London a capital generates 22% of UK GDP despite accounting for only 12.5% of the UK population.

While the very developed and prosperous West Germany was able to thrive despite having gradually built up expensive and inflexible labor and welfare systems, poor and underdeveloped East Germany had to absorb a first would regulatory framework overnight while still having, at best, second world competitiveness.

By allowing tax competition and a special economic zone, East Germany would have most likely developed more rapidly and would have become more prosperous. This option would have cost nothing - A bargain compared to the three trillion US Dollar German taxpayers spent on transfer payment to the former East.