Occasional Paper No. 75

German Unification

Economic Issues

Edited by Leslie Lipschitz and Donogh McDonald

View Full Size

• Download Figure
• Download figure as PowerPoint slide

International Monetary Fund

Washington, D.C.

December 1990

© 1990 International Monetary Fund

Reprinted 1993

Library of Congress Cataloging-in-Publication Data

German unification : economic issues / edited by Leslie Lipschitz and Donogh McDonald.

p. cm. — (Occasional paper / International Monetary Fund ISSN 0251-6365 ; no. 75)

“December 1990.”

Includes bibliographical references.

ISBN 1-55775-200-1

1. Germany (West)—Economic Policy—1974- 2. Germany (West)—Economic conditions—1974- 3. Germany (East)—Economic policy. 4. Germany (East)—Economic conditions.

I. Lipschitz, Leslie. II. McDonald, Donogh. III. Series: Occasional paper (International Monetary Fund) ; no. 75.

HC286.7.G447 1990

330.943′0879—dc20

90-26503

CIP

Price: US$10.00

(US$7.50 to full-time faculty members and students)

Please send orders to:

External Relations Department, Publication Services

International Monetary Fund, Washington, D.C. 20431

Tel: (202) 623-7430

Telefax: (202) 623-7201

Contents

• Preface

• Map of Germany

• Federal Republic of Germany and German Democratic Republic: Comparison of Economic and Social Indicators in 1988

• I Introduction and Overview

• Leslie Lipschitz

• The Two Economies on the Eve of Unification

  • The Situation in the FRG

  • The Situation in the GDR

  • Dismembering the State in the GDR

• Economic Policies

  • The Process of Economic Integration

    • Monetary Union

    • The Enterprise System, the Trust Fund, and the Real Economy

    • The Government and the Social Security System

  • The Stance of Policies

    • Fiscal Policy

    • Monetary Policy

    • The Exchange Rate

• A Guided Tour and Some Tentative Conclusions

  • A Guided Tour

  • Some Tentative Conclusions

• II Economic Developments in the Federal Republic of Germany

• Thomas Mayer, Donogh McDonald, Garry J. Schinasi, and Gunther Thumann

• The Real Economy

  • Overview

  • Aggregate Demand

    • Real Domestic Demand

    • Foreign Balance

  • Employment, Wages, and Prices

  • Potential Output and Capacity Utilization

• Developments in Money and Financial Markets

  • Overview

  • Monetary Aggregates

  • Financial Market Developments

    • Interest Rate Developments

    • Exchange Market Developments

• Fiscal Policy and Structural Reform

  • Overview

  • Budgetary Developments in 1989

  • Budgetary Developments in 1990

  • Fiscal Implications of GEMSU

  • Structural Reforms

• Appendix: Statistical Tables

• III German Democratic Republic: Background and Plans for Reform

• Thomas Mayer and Günther Thumann

• Political Situation

• Economic Background

• Recent Economic Situation

• Plans for Reform

  • Systemic Reforms

    • Reform of the Economic Decision-Making Process

    • Privatization

    • Price Reform

  • Monetary Reform

  • Reform of the External Trade System and Structural Adjustment

  • Reform of the Fiscal and Social Security System

• Box 1: A Chronology of the Dissolution of the German Democratic Republic

• Box 2: Selected Economic Reforms, November 13, 1989–April 11, 1990

• Appendix I: Statistical Tables

• Appendix II: A Brief History of Central Planning in the German Democratic Republic

• IV Investment Needs in East Germany

• Donogh McDonald and Günther Thumann

• Supply Conditions in West Germany

  • Initial Conditions

  • Medium-Term Assumptions

• A Supply-Side Framework for East Germany

• Initial Conditions in East Germany

• The Capital Stock in 2001

• Investment Needs

• V East Germany: The New Wirtschaftswunder?

• Donogh McDonald and Günther Thumann

• Introduction

• The Model

• Starting Conditions

• Scenario A

  • Supply Developments

  • Demand Developments

  • Fiscal Developments

• Scenario B

  • Supply Developments

  • Demand Developments

  • Fiscal Developments

• Issues Arising from the Scenarios

  • Supply Issues

  • Demand Issues

  • Fiscal Issues

• Box 1: The Scenarios in Historical Context

• VI Domestic and International Macroeconomic Consequences of German Unification

• Paul R. Masson and Guy Meredith

• Introduction

• A Global Saving-Investment Perspective

• Effects of Migration on Potential Output in Western Germany

• Simulations Using MULTIMOD

  • The Reference Scenario

  • A Less Favorable Output-Inflation Trade-Off

  • An Alternative Scenario with Slower Growth in Eastern Germany

• Alternative Policy Scenarios

  • An Indirect Tax Increase in Western Germany

  • An EMS Realignment

• Concluding Remarks

• Appendix: Changes to MULTIMOD and Sensitivity of the Results to Structural Features

• References

• VII Wage Determination, the Natural Rate of Unemployment, and Potential Output

• David T. Coe and Thomas Krueger

• Wage Determination

  • An Insider-Outsider Model of Wage Determination

  • The Phillips Curve/Natural-Rate Model and the Target-Real-Wage-Bargaining Model

• The Natural Rate of Unemployment and Potential Output

  • The Natural Rate of Unemployment

  • Potential Output and Multifactor Productivity

• Prospects for the Natural Rate of Unemployment and Potential Output

• Summary and Policy Implications

• Appendix: An Empirical Model of the Natural Rate of Unemployment and Potential Output

• References

• VIII Immigration into West Germany: Historical Perspectives and Policy Implications

• Thomas Mayer

• Historical Perspectives

• Effects of Immigration and Policy Response

• Concluding Remarks

• References

• IX Implications of Unification for Saving and Investment in West Germany

• Donogh McDonald

• Background

• The Effects of GEMSU on Saving Behavior in West Germany

  • Econometric Estimates

  • Simulation of the Effects of GEMSU on Saving

• The Effects of GEMSU on Investment in West Germany

  • Econometric Estimates

  • Simulation of the Effects of GEMSU on Investment

• References

• X Monetary and Financial Issues in German Unification

• Garry J. Schinasi, Leslie Lipschitz, and Donogh McDonald

• Mechanics of the Conversion

  • Liabilities

  • Assets

• The Implications of the Conversion Rate

  • Effects on Liquidity

  • Implications for the Labor Market

  • Distributional Effects

• Monetary Control During the Early Stages of GEMSU

• Structural Reform of the East German Banking System

  • The Banking System in the Centrally Planned Economy

  • The Banking Reform of March 1990

  • The Equalization Fund and Equalization Claims

  • Developments in East German Banking After GEMSU

  • Role of Banks in Economic Reconstruction

• Box 1: Monetary Policy Instruments and Procedures in the FRG

• XI The System of Public Finance in the German Democratic Republic and the Challenges of Fiscal Reform

• Günther Thumann

• Outline of the Fiscal System in the GDR Prior to GEMSU

  • Institutional Framework

  • Fiscal Structure

    • Overview

    • Revenue of the Territorial Authorities

    • Expenditure of the Territorial Authorities

    • Social Insurance

• Structural Aspects of Fiscal Reform

  • Institutional Changes

  • Revenue and Expenditure Reform

    • Territorial Authorities

    • Social Insurance

    • Financial Framework for the Fiscal Reforms

• Implications of GEMSU for the Course of Public Finances in East Germany

• XII The Role of Fiscal and Structural Policies in German Unification: Lessons from the Past

• Thomas Mayer

• The Period of Liberalism: Financing the Essential Government Tasks

• The Period of Keynesianism: Restoring Internal Equilibrium

• The Revival of Erhardian Ideas

  • Attempts at “Consolidation”

  • International Concerns: Tackling the External Surplus

  • On the Eve of GEMSU

• Fiscal and Structural Policies in GEMSU

• Tables

• I

  • 1. Germany: Borrowing Requirement of the Public Sector

• II

  • 1. Federal Republic of Germany: Indicators of Economic Performance

  • 2. German Unity Fund: Transfers to Eastern Germany and Their Financing

  • 3. German Unity Fund and Supplementary Federal Budgets: Additional Borrowing Related to East Germany

  • 4. Germany: Public Sector Borrowing Requirement, 1990

  • A1. Federal Republic of Germany: Aggregate Demand

  • A2. Federal Republic of Germany: Distribution of Income

  • A3. Federal Republic of Germany: Household Income and Consumption

  • A4. Federal Republic of Germany: Balance of Payments Summary

  • A5. Federal Republic of Germany: Regional Breakdown of Foreign Trade

  • A6. Federal Republic of Germany: Services Account

  • A7. Federal Republic of Germany: Earnings, Employment, and Productivity

  • A8. Federal Republic of Germany: Growth of the Main Monetary Aggregates

  • A9. Federal Republic of Germany: Interest Rates

  • A10. Federal Republic of Germany: Exchange Rates

  • A11. Federal Republic of Germany: Long-Term Capital in the Balance of Payments Accounts

  • A12. Federal Republic of Germany: Territorial Authorities’ Finances

  • A13. Federal Republic of Germany: Territorial Authorities—Tax Revenue

  • A14. Federal Republic of Germany: General Government—Revenue and Expenditure

  • A15. Federal Republic of Germany: Selected Indicators of the Size of the General Government

  • A16. Federal Republic of Germany: Financial Implications of Tax Reform

  • A17. Federal Republic of Germany: Subsidies

  • A18. Federal Republic of Germany: Fiscal Assistance and Tax Relief of the Federal Government

  • A19. Comparison of Subsidies in the European Community, 1981–86, Average

  • A20. International Comparison of Subsidies, 1979–87

• III

  • A1. German Democratic Republic: Average Monthly Gross Wage Income by Sector

  • A2. German Democratic Republic: Income and Money in Circulation

  • A3. German Democratic Republic and Federal Republic of Germany: Selected Consumer Prices, 1985

  • A4. German Democratic Republic: Government Revenue and Expenditure

  • A5. German Democratic Republic: Consumption of Private Households, 1985

  • A6. German Democratic Republic: Purchasing Power of the Mark

  • A7. German Democratic Republic: Consolidated Balance Sheet of the Credit System as of December 31, 1989

  • A8. German Democratic Republic: External Trade

  • A9. German Democratic Republic: External Trade with IMF Member Countries

  • A10. German Democratic Republic: External Trade by Major Products

  • A11. German Democratic Republic: Payments Received from the Public Sector of the Federal Republic of Germany

  • A12. Balance of Payments of the Federal Republic of Germany with the German Democratic Republic

  • A13. German Democratic Republic: Employment by Sector and Type of Ownership, 1988

  • A14. German Democratic Republic: Interest Rates as of End-1989

• IV

  • 1. West Germany: Key Supply-Side Data

  • 2. East Germany: Initial Production Conditions Based on 35 Percent Relative Productivity Level

  • 3. East Germany: Initial Production Conditions Based on 30 Percent Relative Productivity Level

  • 4. East Germany: Capital Requirements in 2001

• V

  • 1. Federal Republic of Germany: Regional Profile of Output and Employment, 1987

  • 2. East Germany: Key Supply-Side Elements of Scenario A

  • 3. East Germany: Demand Pattern Under Scenario A

  • 4. East Germany: Government Finances Under Scenario A

  • 5. East Germany: Key Supply-Side Elements of Scenario B

  • 6. East Germany: Demand Pattern Under Scenario B

  • 7. East Germany: Government Finances Under Scenario B

• VI

  • 1. Demands on Global Saving Due to GEMSU: Increased Net Imports of Eastern Germany

  • 2. Global Saving, Investment, and Government Deficits for 1989

  • 3. Germany: Reference Scenario Effects on GEMSU in a Saving-Investment Model

  • 4. Germany: Scenarios of German Unification, 1990–2001

  • 5. Scenarios of German Unification Under Alternative Policies, 1990–2001

  • 6. Recent Interest Rate and Inflation Differentials in the ERM

  • 7. Effects of Changes in Interest Rates on Consumption and Investment in MULTIMOD

  • 8. Scenarios of German Unification with Alternative Model Parameter Values, 1990–2001

  • 9. Long-Run Relative Price Elasticities of Traded Goods in MULTIMOD

• VII

  • 1. Federal Republic of Germany: The Natural Rate of Unemployment

  • 2. Federal Republic of Germany: Contributions to Output Growth in the Private Nonfarm Sector

  • 3. Federal Republic of Germany: Contributions to Potential and Quasi-Potential Output Growth in the Private Nonfarm Sector

  • 4. West Germany: Potential and Quasi-Potential Output Growth in Private Nonfarm Sector

  • 5. Federal Republic of Germany: Variable Definitions

  • 6. Equation Specification

  • 7. Three-Stage Least Squares Estimation Results

• VIII

  • 1. Federal Republic of Germany: Immigration from the East and Macroeconomic Developments

  • 2. Federal Republic of Germany: Regional Distribution of Earnings of Blue-Collar Workers, 1988

  • 3. Federal Republic of Germany: Migration and Unemployment

  • 4. West Germany: Economic Effects of Immigration—Main Simulation Results

• IX

  • 1. Federal Republic of Germany: Equations for the National Saving Rate

  • 2. Federal Republic of Germany: Additional Equations for the National Saving Rate

  • 3. West Germany: Assumptions for the Effects of GEMSU on Selected Variables

  • 4. West Germany: Effects of GEMSU on Net National Saving

  • 5. Federal Republic of Germany: Equations for Machinery and Equipment Investment

  • 6. West Germany: Effects of GEMSU on Machinery and Equipment Investment

• X

  • 1. German Democratic Republic: Consolidated Balance Sheet of the Credit System Before and After Currency Conversion

  • 2. Estimates of the Money Supply in Germany Under Various Conversion Proposals

• XI

  • 1. German Democratic Republic: State Budget

  • 2. German Democratic Republic: Revenue of the Territorial Authorities

  • 3. German Democratic Republic: Expenditure of the Territorial Authorities

  • 4. German Democratic Republic: Revenue of the Social Insurance System

  • 5. German Democratic Republic: Expenditure of the Social Insurance System

  • 6. East Germany: Central Government Budget in the Second Half of 1990

  • 7. East Germany: Sources of Expenditure Overruns in the Budget for the Second Half of 1990

• Charts

• I

  • 1. Federal Republic of Germany: Developments in 1980-89

  • 2. Federal Republic of Germany: Indicators of Fiscal and Monetary Policy, 1980–89

• II

  • 1. Federal Republic of Germany: Immigration from the German Democratic Republic and Eastern Europe, First Quarter 1986–Second Quarter 1990

  • 2. Federal Republic of Germany: Labor Share of Net National Product, 1955–89

  • 3. Federal Republic of Germany: Inflation, 1984–90

  • 4. Federal Republic of Germany: Construction Prices and Consumer Prices, First Quarter 1961-Third Quarter 1990

  • 5. Federal Republic of Germany: Inflation-Output Loops, 1961–89

  • 6. Federal Republic of Germany: Pattern of Growth Cycles, 1967–90

  • 7. Federal Republic of Germany: Monetary Targets and Monetary Developments, January 1985–September 1990

  • 8. Federal Republic of Germany: Interest Rate Developments, January 1985–September 1990

  • 9. Federal Republic of Germany: Exchange Rate Developments, First Quarter 1980–Third Quarter 1990

  • 10. Federal Republic of Germany: Bilateral Exchange Rates and Interest Rate Differentials vis-à-vis the Deutsche Mark. January 1987-October 1990

  • 11. Federal Republic of Germany: Selected Indicators of Fiscal Policy, 1950–89

• V

  • 1. Scenarios for East Germany, 1991–2001

• VI

  • 1. Determination of Real Exchange Rate (∊) and World Interest Rate (R)

  • 2. Alternative Scenarios of German Unification: Results for Germany, 1990–2004

  • 3. Scenarios of German Unification Under Alternative Policy Response: Results for Germany, 1990–2004

  • 4. Scenarios of German Unification Under Alternative Policy Response: Results for Other ERM Countries, 1990–2004

  • 5. Capacity Utilization Rates in the Federal Republic of Germany, 1970–91

  • 6. Alternative Output/Inflation Trade-Offs

  • 7. Scenarios of German Unification with Alternative Parameter Values, 1990–2004

• VII

  • 1. Federal Republic of Germany: Output and Unemployment, First Quarter 1968-Fourth Quarter 1989

  • 2. Unemployment Persistence in an Insider-Outsider Model

  • 3. The Phillips Curve/Natural-Rate and Target-Real-Wage-Bargaining Models

  • 4. Federal Republic of Germany: Potential and Quasi-Potential Output and the Natural Rate of Unemployment, First Quarter 1968–Fourth Quarter 1989

• IX

  • 1. Federal Republic of Germany: Factors Influencing National Saving, 1961–89

• X

  • 1. German Democratic Republic: Simplified Outline of the Banking System and Interbank Relations at the Time of the Currency Conversion

Preface

In January 1989 three of the authors of this volume were involved in the publication of a shorter paper entitled The Federal Republic of Germany: Adjustment in a Surplus Country. Some readers of that paper were surprised by its forthrightness. The Financial Times of London, noting that the IMF “pulls no punches in its criticism” and marveling at “Bonn’s policy of openness” at agreeing to publication, characterized it as “a fit of glasnost” by the International Monetary Fund. In fact, the German authorities had been most helpful in the preparation of the paper and had never tried to stifle the criticism in it; neither they nor their representatives at the IMF had questioned the authors’ decision to publish the paper.

The present volume comes at an even more interesting time. The papers, written initially for distribution within the IMF, afforded the authors the privilege of being close witnesses to historical changes in Germany, and forced them to try and stand apart from the euphoria of the unification process and evaluate its implications. The authors are enormously indebted to many public officials in Germany, who, despite considerably increased work loads, took great pains to enlighten and inform, to answer many questions, and to correct factual and technical errors. But the discussions with German officials did more: they transmitted to the authors some of the enthusiasm—the sanguine, almost heady, atmosphere—that was the context of German economic policymaking in 1990.

The rapid pace of developments in Germany, coupled with the inevitable time lag between preparation and publication, presents two problems. First, the data in the paper generally represent the available estimates and projections at the end of September or early October 1990—much of this will probably be out of date by the new year. The second problem is one of terminology: the area called the German Democratic Republic (GDR) became part of the Federal Republic of Germany (FRG) on October 3, 1990. In general, the designation GDR is used in referring to the pre-unification period and east Germany (as distinct from west Germany) to the post-unification period. Similar problems exist with currencies: GDR marks ceased to exist as legal tender on July 1 and deutsche mark became the sole legal tender in the FRG and the GDR. The authors take some pains to avoid confusion in these terms, but it is not always easy.

The responses to the earlier paper on Germany influenced the structure of this volume. On that occasion, in an attempt to keep the paper slim, the arguments were buttressed with references to various unpublished background notes. Many readers, however, wanted the whole picture, and were quick to request copies of these notes. For this reason the present volume is more comprehensive. While in form it resembles a conference volume (authors are listed for each paper), the extent of cooperation, review, and criticism from within the team was much greater than is apparent. In addition, the authors are indebted to Manuel Guitián (who led the 1990 IMF consultation mission to Germany) and to many other colleagues for helpful suggestions and comments, to Behrouz Guerami and Jolanta Stefanska for research assistance, to Esha Ray for editorial assistance, and to Valerie Pabst and Marie Ricasa for secretarial support. The authors bear sole responsibility for any factual errors. The opinions expressed are those of the authors and should not be construed as representing the views of the German authorities, Executive Directors of the IMF, or other members of the IMF staff.