All Commentary
Tuesday, October 1, 1991

Pains of the German Unification

Dr. Sennholz heads the Department of Economics at Grove City College in Pennsylvania.

Eastern Germany is lingering in deep depression. Of all the struggling former Soviet satellites, it was expected to succeed most quickly. At a stroke, on July 1,1990, the German mark became the common currency, opening the doors to one of the world’s richest sources of investment capital. The West German government stood by with hundred-billion-mark grants and credits, and millions of fellow citizens were eager to help in any way possible. Yet, despite these extraordinary advantages, East Germans are suffering probably the deepest depression in Eastern Europe. In 1990 their gross national product dropped by 14 percent, and almost 30 percent of their 9½ million workers are either unemployed or working short-time. According to many studies, this figure is likely to rise further in the coming months.

The pains of unemployment threaten to render the dream of unification a political and economic nightmare. Integrating two such unequal economies—an ossified command system with a prosperous market order—is an unprecedented task. Even under ideal market conditions, it would have taken many months of adjustment to merge the two parts into one homogeneous whole. Unfortunately, the German government compounded the difficulties by imposing its strictures on the adjustment process. It imposed the costs and regulations of one of the most expensive welfare states on the newcomers, thereby paralyzing all but a few highly productive enterprises.

The principal reason for the East German depression is the rapid rise in East German labor costs. Despite massive regional unemployment, wages are rising with astonishing vigor, driven by the most generous unemployment compensation system in the world. It pays an average worker 68 percent of previous earnings for two years. Encouraged by vocal labor leaders and thoughtless politicians, workers expecting a shutdown of their decrepit facilities demand immediate raises so they can draw the highest possible benefits when their plants finally close. As labor costs are pushed far beyond labor productivity, jobs disappear at astonishing rates.

East Germans are longing for wage equalization with West Germans. Collective-bargaining contracts call for equal pay by 1994 in a number of industries such as metallurgy, electrical engineering, and retailing. But it is unlikely that one in 10 East German enterprises will stay afloat in competitive markets. With labor productivity at less than one-half of that in West Germany, by 1994 many more East Germans are likely to subsist on unemployment compensation. For the moment, non-dismissal agreements and provisions governing short-time working, financed by large West German subsidies, are holding back the worst.

Privatization Efforts Hindered

Excessive labor costs in eastern Germany may also explain why privatization of state enterprises is proceeding so slowly. In Poland and Czechoslovakia, governments are planning to give away most state-owned enterprises, using vouchers made available to all citizens. In eastern Germany, in contrast, the Treuhandanstalt (Trusteeship Authority) is supposed to sell some 8,000 state enterprises at equitable prices. Until now it has rejected most bids for being too low and not meeting its onerous labor conditions. Unfortunately, it makes matters worse: for the protection of eastern workers it seeks to extract expensive employment and wage guarantees from potential buyers, which obviously depresses the price offered for an enterprise, which in turn causes the Treuhandanstalt to reject the offer. In the end, few, if any, government enterprises are sold. They are likely to be shut down and their workers discharged when the western subsidies run out.

Few western companies have established or plan to establish plants in the east. East German labor is just too expensive at present rates. The situation is compounded by bureaucratic logjams and disputes over property rights. Even if the Trusteeship Authority were to offer a facility at market prices, which would be a rare exception, it might be enjoined from doing so by litigation initiated by the former owners. Thousands of victims of Communism are pressing claims for compensation or return of their property in the courts of law; the Trusteeship Authority is opposing these claims, clinging to property as if it were its own.

Other factors compound the employment situation, which is leading to growing social tension and political uncertainty. When the two Germa-nies merged into one and migration barriers were lifted, the two parts formed one comprehensive labor market. According to all principles of economics, West German wage rates should have fallen and East German wages should have risen as eastern labor moved west and western business moved east until, in a few years, both parts would have been equal in labor productivity and income. A small drop in western labor costs would have raised the demand for labor sufficiently to absorb the influx of workers from the east. But instead of reducing western labor costs, powerful unions have managed to boost costs by about 6 percent since unification. This increase alone would have tended to raise unemployment. For the East Germans it closed many doors to employment in the west and forced them to stay at home subsisting on unemployment compensation.

Another factor aggravating the employment situation is the massive influx of Eastern Europeans. With the disintegration of the Communist empire and the dismantling of many migration barriers, millions of Eastern Europeans are seeking a new beginning in western Germany. During 1989 some 700,000 immigrants arrived in West Germany; in 1990 this number exceeded one million, and is likely to rise further during 1991 and the coming years. The movement at first eased the acute shortage of skilled workers in West Germany but now is compounding the employment difficulties of many East Germans.

Roots of Unemployment

Employment and unemployment always are a function of labor costs, not of the costs of equipment. The cause of the German dilemma is not East Germany’s poor quality of plant and equipment. Millions of workers throughout the Communist world and in less developed countries around the globe earn a living with similar or even less efficient facilities. But they do not agitate for policies that will price themselves out of employment because they have no one to support them. Inferior equipment keeps labor less productive; it doesn’t render it completely unproductive and doesn’t force it to be idle. It is foolish to blame old equipment for one’s unemployment.

The depression was not caused by the terms of monetary unification, as Karl Otto Pohl, president of the Bundesbank, wants us to believe. In preparation for monetary union he had proposed an exchange rate limit of one D-mark for two rather worthless East-marks. Chancellor Helmut Kohl insisted on a parity of exchange, arguing that the two-to-one rate would penalize eastern savers and pensioners and encourage eastern workers to move westward. In reality, both exchange rates were political rates rather than purchasing-power market prices, which before the union had stood at seven-to-one. Both rates in effect included generous gifts to every East German, especially the savers and pensioners. But monetary gifts by themselves don’t directly affect the price of labor, which is determined by the productivity of labor. East German labor could have priced itself out of employment as easily at a two-to-one rate of exchange as it did at the one-to-one rate. The push for wage equalization would have been the same.

Some observers blame the eastern German depression on the disintegration of trade with former Eastern-bloc countries, such as Poland, Czechoslovakia, Hungary, Romania, and Bulgaria. This was the region that previously had bought seven-tenths of all East German exports. The disintegration of the old trade pattern obviously necessitates painful readjustments, which makes the need for flexibility and adaptability all the greater; unfortunately, the strictures of labor laws and regulations render the necessary adjustments rather difficult.

Many Germans and most people abroad are convinced that Germany will succeed in overcoming its difficulties and, in the end, emerge more prosperous than before. They point to a few rays of hope such as the large and still growing number of new businesses that emerge every day. Since the beginning of 1990, some 400,000 new businesses have been registered. The main focuses of these new enterprises are the craft trades and the service industries. Here the first stirrings of the recovery process are clearly visible.

The new stirrings may contain an answer to the economic dilemma. In years to come they may develop into the mainstream of economic production while the Treuhand sector is bound to shrink in direct proportion to the decreasing subsidies it manages to extract from the body politic. In the meantime, however, the deep depression and mass unemployment in eastern Germany are bound to leave their mark not only on the economic well-being of millions of victims but also on their political thoughts and prejudices. Many may argue that, under Communism, they at least had jobs. Under capitalism, or what they now believe to be “capitalism,’ they feel rejected and forced to subsist on alms from the West. A resentful East German population may even turn against the new order and cast its lot with the foes of democracy and the private-property order.

  • Hans F. Sennholz (1922-2007) was Ludwig von Mises' first PhD student in the United States. He taught economics at Grove City College, 1956–1992, having been hired as department chair upon arrival. After he retired, he became president of the Foundation for Economic Education, 1992–1997.