German reunification shows what wealth transfer can achieve

But it is one thing helping kith and kin in the east, another bailing out Club Med nations in the south

Hamish McRae
Sunday 09 November 2014 01:00

It was the great symbolic moment, 25 years ago, in that series of events that led not just to a reunified Germany but to the European Union we have today. Germany and the rest of eastern Europe took very different paths in their transformation from command economies to market ones. So we had one of those rare real experiments in economics: which path was better? But the story has another twist. Who could have predicted a quarter of a century ago that economic distress in the enlarged EU would not be among the accession states but in core members such as Italy and even France?

The German model shows what can and cannot be achieved by huge subsidies from richer regions to poorer ones. When Germany reunified it was agreed the East German mark should be convertible one-for-one with the West German mark. The Bundesbank opposed this, arguing that a more appropriate rate would be two-for-one, recognising the much lower productivity of the East. Politics prevailed. The resulting surge in unemployment from a non-competitive exchange rate had to be offset by massive subsidies from the West. Add in the investment needed to bring crumbling infrastructure to West German standards and the annual transfer at some points reached about 8 per cent of GDP.

Thanks to the generosity of West German taxpayers, the gap has been narrowed. Infrastructure in the East is now pristine, yet it remains poorer and westward migration continues. In Berlin the gap is less obvious, as it was before the Wall fell. That is partly because the grander bits of the city happened to be in the East, partly because cheap rents in the East have supported a vibrant artistic community – hence the Berlin tag "poor but sexy". Elsewhere the fissures are still evident. It seems to take more than a generation to reverse communism's economic damage, even with an almost unimaginable transfer of wealth.

Such transfers were not available to the rest of eastern Europe. They had to take a different route: devaluation and deregulation. Results have been uneven. There have been successes. Poland was the only country in Europe to come through the last downturn without going into recession. Slovakia has become a large car manufacturer, offering cheaper costs than western Europe. Estonia is a pioneer in communications technology. But it has not been easy and the fact that so many eastern Europeans seek work in the UK is evidence of the gap in opportunities that still exists.

So I don't think you can say that one path was better or worse, simply that the different countries had to do what they had to do. In the case of most, it was having to accept a sharp though temporary fall in living standards. For a while they were much poorer. For East Germany it was accepting a loss of control and the imposition of the standards of a very different society. A few weeks after the fall of the Wall, I remember talking with Christa Luft, economics minister in the East German government. She said she hoped that after reunification elements of East German values would influence the West. It would not be a one-way street. I think most Germans would accept that this has not happened.

The more prosperous parts of Germany have been affected in a different way – by writing the cheques. But while it might be acceptable to fund your kith and kin as a price for getting your country back together, having to support the living standards of profligate southern Europeans is a different matter. The opposition to back-door bailouts of the Club Med countries by the European Central Bank is rooted in the experience with East Germany. It may in part explain German reluctance to help Britain in its efforts to hold down the price of EU membership. If we pay less, someone else will have to pay more. Who is that likely to be?

The frustration with the indebted countries of southern Europe is all the greater because of the sacrifices made by Germans in the early years of euro membership. Germany joined the euro at what was then too high a rate and had to squeeze its costs to achieve its present competitiveness. It had to push through the sort of internal devaluation facing Italy, Spain and to some extent France. If it could do so, why can't they? There was a telling story last year in the German press as to how the wealth of Italians was greater than the wealth of Germans. To subsidise poorer people is understandable, but richer ones ...

Germany, post unification, is surely a success story, even if the process has proved far harder than thought. EU enlargement has been a success story, though perhaps a qualified one. So Europe has pulled the East in with the West. But what no one could have predicted, 25 years ago, is that Italy would be mired in recession year after year, or that half the youth of Spain would be unemployed.

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