East Germans had been disenchanted with their country’s economic and political system for many years, but opposition was suppressed. Following major political changes in the U.S.S.R. and reforms in Poland and Hungary, opposition in the German Democratic Republic (GDR) came into the open during 1989. A sizable number of GDR citizens voted with their feet, that is, they emigrated to western Germany; many of those who stayed held mass demonstrations.1 In October 1989, under the pressure of these developments and lacking support from the U.S.S.R., the Secretary General of the Socialist Unity Party (SED) and chief of state Erich Honecker resigned. In an attempt to defuse the crisis, the borders to the west were opened on November 9, paving the way for a massive wave of emigration.2

Thomas Mayer and Giinther Thumann

Political Situation

East Germans had been disenchanted with their country’s economic and political system for many years, but opposition was suppressed. Following major political changes in the U.S.S.R. and reforms in Poland and Hungary, opposition in the German Democratic Republic (GDR) came into the open during 1989. A sizable number of GDR citizens voted with their feet, that is, they emigrated to western Germany; many of those who stayed held mass demonstrations.1 In October 1989, under the pressure of these developments and lacking support from the U.S.S.R., the Secretary General of the Socialist Unity Party (SED) and chief of state Erich Honecker resigned. In an attempt to defuse the crisis, the borders to the west were opened on November 9, paving the way for a massive wave of emigration.2

After the opening of the border, the pace of events quickened. In the GDR, a new government was constituted in mid-November with reform-communist Hans Modrow as prime minister while, later in the month, Chancellor Kohl proposed a ten-point plan for eventual unification of the two parts of Germany (see Box 1). Although it initially met considerable skepticism from both the GDR Government and opposition groups, Kohl’s plan—and the idea of unification—gained popularity in the GDR after revelations of widespread corruption among the former leadership and the subsequent resignation of party chief Krenz together with the Politburo and Central Committee of the SED in early December. The Modrow Government was not affected by this shakeup, but serious difficulties arose in early January 1990 when it was revealed that Prime Minister Modrow had retained about three fourths of the state security forces (Stasi), despite promises that he would disband the organization and establish a new state security agency before the elections scheduled for May. Toward the end of January, the political and economic situation became more fragile. Emigration was running at a daily rate of 1,500 to 3,000 people, output was declining, and government authority was vanishing. In order to avoid political and economic collapse, Modrow broadened his government by including eight representatives of the major opposition groups and advanced the date of the elections from May 6 to March 18.3

With the political and economic situation in the GDR deteriorating rapidly, the Government of the FRG decided in early February to offer economic and monetary union between the two German economies at a much earlier stage than originally envisaged in the ten-point plan. The run-up to the March parliamentary elections was heavily influenced by the debate on this offer. Although all the parties were in favor, there were considerable differences about the speed with which economic and monetary union should be achieved. In contrast to the other parties, the conservative Alliance for Germany (consisting of the CDU—one of the old block parties—as well as the newly founded German Social Union and Democratic Awakening) favored a quick path. The election victory of the CDU, which had received large-scale support from its sister party in the FRG, was seen as a clear endorsement by the GDR electorate of early adoption of the FRG’s offer. And, indeed, shortly after the formation of a new government in mid-April with CDU chairman Lothar de Maizière as Prime Minister, agreement was reached with the Bonn Government on the basic conditions for German economic, monetary, and social union (GEMSU). The legislative process was accelerated so that the agreement could take effect on July 1, 1990.

A Chronology of the Dissolution of the German Democratic Republic


Phase I—The Dictatorship Comes to an End

August-September: Large numbers of GDR citizens occupy FRG embassies in several Eastern European countries in order to obtain permission from the GDR Government for emigration.

September 10: Hungary opens its border with Austria to GDR citizens, suspending a 1968 agreement with the GDR Government that required Eastern European countries to block travel of GDR citizens to the West.

September 11–14: More than 13,000 GDR citizens leave Hungary en route to the FRG via Austria—the largest exodus from the GDR to the West since the Berlin wall was built in 1961. The GDR closes its border with Hungary.

September 30: With permission from the GDR Government, more than 17,000 refugees from the GDR emigrate to the FRG via Czechoslovakia and Poland.

October 3: The GDR closes its border with Czechoslovakia.

October 7: Fortieth anniversary of the founding of the GDR. Soviet President Gorbachev visits East Berlin and draws cheers from demonstrators.

October 9: Seventy thousand people demonstrate in Leipzig. General Secretary Honecker orders the demonstration to be stopped, if necessary by force, but security forces do not intervene.

October 16: About 100,000 people demonstrate in Leipzig, the largest unauthorized demonstration in the GDR since 1953.

October 18: Erich Honecker is replaced by Egon Krenz as General Secretary of the ruling SED.

October 24: Egon Krenz is elected Chairman of the State Council (Staatsrat), the second governing body of the GDR.

November 7: The Council of Ministers (Ministerrat), the de facto GDR Government, resigns.

November 9: Borders with the FRG open for all GDR citizens. After 167,000 emigrants in January—October 1989, another 177,000 emigrate to the FRG in November–December, bringing the total for the year to 344,000. In 1988, 40,000 people had emigrated to the FRG.

November 13: Hans Modrow is elected Prime Minister. He proposes a “treaty community” between the FRG and the GDR.

November 18: A new government is sworn in.

November 23: Tighter customs and currency controls and buying restrictions on foreigners in the GDR are announced, triggered by activities of “arbitrageurs” who bought highly subsidized GDR goods for resale in the FRG and Poland.

November 28: Chancellor Kohl proposes a ten-point plan for unification. Its main elements are as follows:

  • Providing humanitarian aid to the GDR, in particular for the health sector where severe shortages emerged after the emigration of a great number of doctors and nurses.

  • Establishing a DM 2.9 billion currency fund (with a DM 2.2 billion contribution by the FRG) allowing GDR citizens, with effect from January 1, 1990, to acquire deutsche mark against marks for travel purposes once a year, at exchange rates of DM 1 = M 1 for the first DM 100 and at DM 1 = M 5 for the second DM 100.

  • Undertaking joint projects with a view to reducing pollution, improving the railway system, and modernizing the telecommunications system in the GDR.

  • Establishing linkages in all areas of public life based on intergovernmental treaties after free elections had taken place in the GDR.

  • Developing confederative structures between the FRG and the GDR.

  • Creating a FRG-GDR confederation in the context of European integration and in line with the Helsinki agreements on human rights.

December 1: The parliament (Volkskammer) in the GDR deletes the guarantee of a “leading role for the SED” from the Constitution of the GDR.

December 3: After revelations of widespread corruption among the former SED leadership, party chief Krenz resigns, together with the Politburo and the Central Committee of the SED. General elections are scheduled for May 6, 1990.

December 9: Gregor Gysi, a lawyer who had defended dissidents, is elected SED chairman.

December 20: Chancellor Kohl visits the GDR and an agreement is reached on economic cooperation in several areas.


Phase II—On the Road to Free Elections

January 12: The GDR Constitution is changed to allow the establishment of a market-oriented economy. Specifically, in addition to state, cooperative, and mixed ownership, private ownership of production facilities and joint ventures with foreign companies are made possible (although many restrictions apply).

End-January: Emigration continues at a rate of 1,500–3,000 people a day. The Modrow Government, fearing economic and political collapse, advances the date of elections to March 18 and includes members of the major opposition groups in a grand coalition.

February 1: Prime Minister Modrow proposes a plan for German unity after talks in Moscow.

February 6: Chancellor Kohl offers negotiations on a currency union of the FRG with the GDR.

February 12: Talks involving the two German states and the four Allied powers with rights in Germany (France, the United Kingdom, the United States, and the U.S.S.R.), the so-called 2 + 4 talks, begin in Ottawa.

March 18: In the parliamentary elections, the Conservative Alliance for Germany wins a surprise victory with 48 percent of the vote (CDU—41 percent; German Social Union (DSU)—6 percent; and Democratic Awakening (DA)—1 percent). The Social Democratic Party (SPD) receives 22 percent, the Party of Democratic Socialism (PDS, formerly SED) 16 percent, and the Liberal Party 5 percent of the vote.

Phase III—Establishing Economic, Monetary, and Social Union

April 2: The Bundesbank publishes its proposal for a conversion law to become part of a treaty on German economic, monetary, and social union (GEMSU) between the FRG and the GDR. The proposal consists of six basic points.

  • On the designated day, all domestic liabilities in the GDR and payments for current transactions (e.g., wages and pensions) would be converted into deutsche mark at a rate of M 2 = DM 1. Wages and pensions would, however, be adjusted to compensate losses of purchasing power as a result of price reform prior to conversion. Preferential treatment would be given to individual bank accounts of up to M 2,000 a person, which would be converted at a rate of M 1 = DM 1.

  • In light of the less favorable treatment for accounts larger than M 2,000, the Government of the FRG would suggest in negotiations with the GDR that savers be guaranteed a stake in assets held by the State in trust for the people.

  • The accord between the FRG and the GDR would also guarantee that in regard to monetary policy in the GDR, only the Bundesbank law and Bundesbank regulations would apply. Moreover, the Bundesbank would be able to implement in the GDR all monetary policy decisions made by its central council.

  • To fulfill its responsibilities, the Bundesbank would open a provisional administrative office in East Berlin and about 15 other branch offices in the GDR.

  • The commercial banking law of the FRG would be introduced in the GDR, allowing FRG banks and foreign commercial banks to open offices. Regulations on interest rates and foreign exchange limits in the GDR would be removed.

  • Borrowing by the GDR public authorities would be limited.

April 12: A grand coalition government between the CDU, SPD, DSU, DA, and the Liberals is formed in the GDR with Lothar de Maizière (CDU) as Prime Minister. The Government opts for economic, monetary, and social union (GEMSU) with the FRG by mid-1990 and political accession, at a later date, under Article 23 of the FRG’s Basic Law.

April 23: The FRG Government publishes its proposal for the terms of GEMSU. Savings of up to M 4,000 a person (M 2,000 for those under 14 years of age and M 6,000 for those above 58 years of age) would be converted at parity to the deutsche mark; savings exceeding these limits and other financial assets and liabilities would be converted at DM 1 = M 2. Wages and other current payments would also be converted at parity. Pensions would be linked to net wages, with a pension after 45 years of employment typically reaching 70 percent of average net income.

May 18: The Finance Ministers of the FRG and the GDR sign the State Treaty establishing GEMSU.

June 22: The State Treaty is ratified by the parliaments of the FRG and the GDR.

July 1: GEMSU takes effect.

Phase IV—Approaching Political Union

July 15–16: A meeting in the Caucasus between President Gorbachev and Chancellor Kohl results in approval from the U.S.S.R. for German unification, with the united Germany a member of the North Atlantic Treaty Organization (NATO).

August 3: An election treaty is signed, stipulating accession of the GDR to the FRG before all-German elections on December 2, 1990.

August 31: The Unity Treaty is signed, providing the legal basis for unification and the transition rules.

September 12: The 2 + 4 talks end; a treaty is signed terminating the rights of the Allied powers in Germany.

October 3: The five GDR states—Brandenburg, Mecklenburg-West Pomerania, Saxony, Saxony-Anhalt, and Thuringia—accede to the FRG under Article 23 of the FRG Constitution; the GDR ceases to exist.

The deep-rooted economic problems that became more apparent after GEMSU took effect, as well as other political and administrative difficulties, added further momentum to the unification process. In the summer, the two Governments agreed to advance political unification of the two parts of the country to October 3, 1990. A Unification Treaty was agreed in August and ratified by the parliaments of the FRG and the GDR in September, stipulating among a host of transition and other regulations4 that the five Länder5 of the GDR would accede to the FRG under Article 23 of the FRG’s Constitution.

Economic Background

Until 1989, official statistics painted a rosy picture of the GDR economy. According to these statistics, net material product (NMP—broadly equivalent to net domestic product but excluding part of the services sector)6 increased in real terms at an average annual rate of 4 percent in 1980–88. Net investment grew by 2 percent a year and real per capita disposable income by 4½ percent a year. Prices were stable, the external accounts generally in surplus, unemployment nonexistent, and government accounts in balance.

Economic performance, in fact, was much worse.7 This poor performance can be attributed to several factors. First, the increased emphasis on central planning since the early 1970s rendered the already inflexible economic system even less able to adjust to the external shocks of the 1970s and 1980s, to the emergence of new technologies, and to changing consumer tastes. Second, the pursuit of economic autarky resulted in a lack of integration into the world economy that deprived the GDR economy of the impulses that result from external competition. Third, the concentration of investment in a few selected technology-intensive areas8 led to a deterioration of the capital stock in many other areas, most notably in the consumer durables industry and the public infrastructure.9 Fourth, increased reliance on lignite coal instead of mineral oil for energy production enabled the authorities to avoid measures to increase efficiency in the use of energy and contributed to severe air pollution.10 Fifth, the all-pervasive regulation of the labor market, the rigid wage structure with little wage differentiation (Table A1), and the low sectoral and regional mobility of labor added to the inefficiencies. Last, but not least, the rising gap in living standards between the GDR and the FRG, as well as the unresponsiveness of the leadership to the emerging problems (and its harsh rejection of reforms), contributed to a declining morale in the workforce.

As a result, productivity in the GDR lagged far behind that in the FRG. The magnitude of the productivity gap has been the subject of much debate. Based on production data and input-output relationships published by the GDR authorities and prices in the FRG, the Deutsches Institut für Wirtschaftsforschung (DIW) estimated the productivity gap in the industrial sector at about 50 percent on average in 1983.11 However, a more recent analysis suggested that, for the economy as a whole, productivity was about 40 percent of the FRG level.12 In a study based on a different methodology, the DIW estimated that in the GDR about three times as many workers as in the FRG were needed to achieve a given level of export revenues in convertible currency.13 Comparisons of GNP per capita were less unfavorable to the GDR, as the ratio of the labor force to population was much higher in the GDR, reflecting, in particular, higher participation rates.

Given the dubious quality of the data base and the methodological problems, these various estimates can only serve as broad, backward-looking benchmarks. For example, measures of productivity based on physical production data are limited by difficulties in taking account of quality differences—the studies mentioned above evaluated GDR production at prices prevailing in the FRG. The approach focusing on export earning power, too, suffers from weaknesses, as, in contrast to a market-oriented economy, the GDR did not necessarily export products in which it enjoyed a comparative advantage. Autarky was a major economic policy objective and areas for exporting seem to have been identified with little regard for their economic returns. More important, estimates of past productivity are not useful indicators of potential productivity with the prevailing capital and labor supplies. It has been suggested, for instance, that productivity could be improved quickly by 20–30 percent if certain inefficiencies arising from interruptions of input supply, absenteeism, and in-house production of inputs were removed.14 On the other hand, much of the output produced prior to the opening up of the GDR economy might not be marketable in an open trading environment. Thus, in the initial months of GEMSU, with the output level falling under pressure from external competition, and some shelter still provided for employment, productivity as measured by the official statistics has been declining.

Although average monthly gross wages in the GDR in 1988 amounted to only a third of west German wages when converted at parity, differences in taxation seem to have narrowed the gap for net wages to about 60 percent.15 But the purchasing power of wages in the GDR was affected by the unavailability of certain goods. Although the supply of basic consumer goods was satisfactory and housing was cheap,16 the supply of consumer durables was limited: only about half of households owned a car or a color television set, which are almost standard possessions in west German households. Moreover, it is doubtful that prices were as stable as officially proclaimed. The basket used for the computation of the consumer price index included low-priced goods that were no longer produced. In addition, companies appear to have been able to raise prices by declaring minor alterations of products as improvements in quality.17 There also seems to have been suppressed inflation that gave rise to a monetary overhang, reflected in the drop in the velocity of money (Table A2).

Apart from suppressed inflation, the GDR economy suffered from a severely distorted price structure, with low prices for basic consumer goods and high prices for “luxury” goods (Table A3). In order to support low prices for basic consumer goods, the Government spent about M 50 billion in 1988, equivalent to 18½ percent of NMP (Table A4). Given the vast differences in relative prices, comparisons of purchasing power of the mark and the deutsche mark depended heavily on the assumed consumer basket. The more the basket was tilted toward basic products, the more favorable was the purchasing power of the mark compared with that of the deutsche mark. Thus, computed purchasing power parities ranged from M 1: DM 1.45 for a two-person pensioner household with a GDR consumption pattern to M 1: DM 0.89 for a four-person wage earner household with a west German consumption pattern (Tables A5A6). Moreover, these calculations overstated the relative purchasing power of the mark owing to the limited availability of certain goods in the GDR and differences in quality.

The mark was only valid for transactions in the GDR and could not be exported or imported legally. External trade data were denominated in valuta marks (VM). Each valuta mark was equivalent to one deutsche mark. The official conversion rate for trade in convertible currencies was M 1 = VM 1 but, in effect, a more depreciated rate was used, which was adjusted from time to time. In 1989 this latter rate was M 4.4 = VM 1.18 Trade with member countries of the Council for Mutual Economic Assistance (CMEA) was denominated in the transferable ruble (TR), which was converted into marks at a rate of TR 1 = M 4.667.19 Until recently, the official exchange rate for tourists was M 1 = DM 1. As of the beginning of 1990, the tourism rate was devalued to M 3 = DM 1.20 The free market rate in West Berlin was about M 9 = DM 1 in October 1989. After the opening of the border it fell temporarily but by January 1990 had recovered to M 7 = DM 1. Following the decision to introduce the deutsche mark in the GDR, the free market rate appreciated considerably.

Contrary to official statistics, it seems that the government budget in the GDR experienced small deficits over the years. According to the financial accounts for 1989, released by the State Bank (Staatsbank) in early 1990, gross domestic liabilities of the Central Government to the banking system amounted to M 50 billion (18 percent of NMP) at the end of 1989 (Table A7).21 Including the housing sector, public liabilities amounted to M 158 billion (57 percent of NMP). Since capital markets did not exist in the GDR, these liabilities reflected the debt that had been created through bank financing of deficits and construction investment. In addition, the indebtedness of the state-owned enterprises had risen to high levels—94 percent of NMP—as profits had been largely used to bolster government revenue.

At the end of 1989, net external indebtedness of the GDR to the non-state-trading area was M 32 billion or about $18.5 billion (see Table A7). This was partly offset by net assets vis-à-vis state-trading countries in the amount of M 10 billion.22 The relatively favorable external debt situation seems consistent with official trade data, which reported moderate external surpluses through most of the 1980s (Table A8). Calculations based on partner country information obtained from the IMF’s Direction of Trade Statistics confirm external surpluses of the GDR with IMF member countries for most of the period 1982–86, but indicate the emergence of deficits in 1987–89 (Table A9). Trade was heavily focused on investment and intermediate goods, with trade in consumer goods particularly small on the import side (Table A10). According to official statistics, about two thirds of external trade was conducted with statetrading countries and only a little more than one fourth with Western industrial countries. In reality, however, the share of state-trading countries was considerably lower, as a significant part of external trade with the convertible currency area went unreported and valuation practices further distorted the picture. Trade in goods between the FRG and the GDR was broadly balanced over the years, but there was a substantial infusion of foreign exchange into the GDR through the net export of services to the FRG as well as through transfers and capital flows (Tables A11A12).

Recent Economic Situation

Economic developments in 1989 were heavily influenced by political turbulence. Reflecting the wave of emigration, the labor force declined by 220,000 (2½ percent) during the year. While NMP rose in real terms by 2 percent on average in 1989, output fell in the final quarter of the year. Emigration of skilled workers seems to have contributed to structural unemployment as, at the end of 1989, there were 50,000 unemployed but 250,000 officially recorded vacancies.

The traces of the political turmoil were particularly visible at the sectoral level. While industrial production increased by 2½ percent for the year as a whole, it declined after the opening of the Berlin wall, and in December was 3 percent below its level of December 1988. Similarly, construction output was broadly unchanged in the annual average but, in December, was about 8 percent below the level of a year earlier. At the same time, demand for transportation and communications services soared; for example, toward the end of 1989, there were 1.2 million unfilled orders for telephone installations.

While aggregate supply weakened through the year in 1989, demand strengthened. Although retail sales rose by only 3½ percent on an annual average basis, there was a private consumption boom toward the end of the year. To finance these purchases, consumers withdrew deposits from savings accounts—M 900 million during the month of November alone—and household savings accounts increased by only M 8 billion during 1989, compared with M 10 billion in 1988; as a result, the household saving rate declined from 7 percent of net money income to 6¼ percent.

The deteriorating economic situation resulted in a weakening of the financial position of enterprises and a decline in profit transfers to the government budget. Reflecting this, the budget was officially reported in deficit to the extent of M 6 billion (2 percent of NMP). The economic difficulties also led to larger increases in the official price index than had been typical in the past—the consumer price index rose by 2 percent in 1989. With wages increasing by about 3 percent, real wages rose (officially) by about 1 percent.

The decline of GDR industry gathered momentum during 1990 with industrial output falling, relative to the corresponding period of the previous year, by 4½ percent in the first quarter and by 9½ percent in the second quarter. In August 1990, the second month in which the GDR economy was fully open to competition, industrial output was 50 percent lower than in the same month of 1989. Construction activity also slumped; in July 1990 it was 15 percent below the level of a year earlier. As a result, unemployment soared. In September, 2.2 million people (one fourth of the labor force) were either registered as unemployed or on short-time work.

Wage developments in 1990 have been clearly out of line with productivity developments. Shortly after GEMSU took effect, wage increases ranging from 25 percent (metals industry) to 60 percent (construction) were granted, often on top of sizable awards in the first half of 1990.23 Moreover, the duration of the new contracts was limited—in most cases to less than six months. These wage developments put further pressure on the financial situation of enterprises as prices became subject to market forces. The July consumer price index was 5½ percent lower than a year earlier.24 Basic goods became more expensive, partly reflecting the abolition of consumer price subsidies, but prices of many durable goods declined as the high excise taxes levied on them no longer applied and pressure of competition from Western goods intensified.

Plans for Reform

Shortly after the opening of the borders, a broad political consensus emerged in the GDR that the command economy could not be repaired. What was needed was radical economic reform. However, the reform steps undertaken by the Modrow Government (Box 2) appeared to be half-hearted and not far-reaching enough. In addition, views differed on how to implement the reform program. While initially the thinking in official and academic circles had been overwhelmingly in favor of a gradual approach to reform in the GDR with economic and monetary union with the FRG being the crowning result of a long restructuring process, the rapidly deteriorating economic situation and increasing political dissatisfaction created pressures for prompt economic unification. It was against this background that, on February 6, 1990, Chancellor Kohl, in a surprise move, offered currency union through introducing the deutsche mark in the GDR.

Currency union, of course, implied that the economic system of the GDR would be subject to international competition and, hence, would have to be reshaped fundamentally. In particular, it would require (1) replacing central planning by decentralized decision making, open markets, and competition; (2) allowing private ownership of land, housing, and production facilities by domestic residents and foreigners; (3) a reform of the banking system (including the central bank); (4) a redefinition of the role of government and a restructuring of the social security system; (5) a phasing out of consumer price subsidies and a freeing of prices (including wages); and (6) a liberalization of external trade. To accomplish these tasks, the Governments of the FRG and the GDR in May 1990 concluded a State Treaty that specified the reforms required in the GDR and set out the terms of GEMSU.

The first chapter of the State Treaty stipulated that the union, which was to go into effect on July 1, 1990, would be based upon the principles of the social market economy, that is, private property, competition, free prices, free movement of labor, capital, goods, and services, as well as labor legislation and a social security system in line with these principles. Chapter II specified the terms of the currency union, particularly the currency conversion rates. Chapter III dealt with several aspects of economic union—external and domestic trade, structural adjustment of GDR enterprises, agricultural policy, and environmental protection. Chapter IV contained the provisions for social union, including the new structure of the social security system and regulations for the unemployment, pension, health, and accident insurance funds. Finally, Chapter V described the fiscal reform and provided for transfers from the FRG to the GDR budget as well as stipulating limits on borrowing by the GDR public authorities. By and large, the State Treaty extended the economic and social system of the FRG to the GDR. Below, the institutional arrangements existing in the GDR prior to GEMSU are described and the implications of the reform process discussed.

Systemic Reforms

The replacement of the centrally planned economy of the GDR by a social market economy had far-reaching implications for economic decision making, property rights, and the price formation process.

Reform of the Economic Decision-Making Process

Economic decision making in the GDR revolved around the establishment and implementation of the central plan (see Appendix II for a brief history of central planning in the GDR). The top decision-making body was the Politburo or, in a somewhat wider context, the Central Committee (ZK) of the Socialist Unity Party (SED).25 The overall framework and the major guidelines for economic policy were determined by the Politburo. Within these guidelines, the Ministerial Council formulated, issued, and controlled a variety of economic plans, the details of which were worked out by the Planning Commission.26 The plans set by the command sphere were passed on in disaggregated form to the operating units of the economy. Instructions were in the form of legal directives and hence binding on the companies concerned. A complicated system of accounts was needed to make plans operational, to coordinate them, and to monitor the results. Although the planning institutions and operating units interacted in various ways, decision making was predominantly top-down. Entrepreneurial activities at the company level were hence discouraged, and consumers remained largely passive at the receiving end of the line of command.

Selected Economic Reforms, November 13, 1989–April 11, 1990

  • Amendment of the Constitution: Private, cooperative, semipublic, and mixed ownership, including joint ventures with foreign investors, were given the same legal status as state ownership.

  • Abolition of certain restrictions on private companies: The limitations on employment by private crafts and retail companies, as well as special levies on investment goods imported by these enterprises, were abolished.

  • Reorganization of the Kombinate: Kombinate were allowed to pursue foreign trade directly; the number of ordinances governing business of the Kombinate was greatly reduced; and companies were given greater independence.

  • Abolition of price subsidies: Subsidies for children’s clothing were abolished and child support payments raised.

  • Reorganization of the banking sector: The State Bank was given the status of an independent central bank and a commercial bank was created to take over the other functions previously held by the State Bank.

  • Establishment of a trust for the management of public property (Volkseigentum): Kombinate, companies, and other entities were to be transformed into joint-stock companies with shares held by the trust.

  • Workers’ rights: A bill was passed in parliament giving extensive rights to workers’ representatives in companies.

  • Reduction of taxes: Tax relief for private enterprises and self-employed was given and taxes on certain “luxury” items were reduced.

GEMSU necessitated a complete revamping of this authoritarian economic system. Chapter I of the State Treaty required that central planning be abolished and replaced by a system of free enterprise, competition, and open markets, that is, by a system based on individual economic decision making. The role of the State was to be limited to the provision of public goods and the maintenance of an economic and social order in line with the principles of the social market economy as it existed in the FRG.

An effective competition policy was seen to be particularly important during the process of restructuring. In the area of traded goods, this could be achieved through the maintenance of an open trading system and the avoidance of government subsidies to specific industries. Strong antitrust laws were needed, however, to prevent the survival or the emergence of monopolistic market structures in the area of nontraded goods. Under the State Treaty, the GDR adopted the FRG’s cartel law with the modification that the GDR cartel office could permit mergers deemed to be in the “general economic interest” even though market dominance might result. Since political unification, the FRG’s cartel law has applied in its entirety in areas formerly part of the GDR.


Expropriation began in the eastern part of the defeated Germany in 1945 when the Soviet military administration confiscated property of the German Reich, the German military administration, the Nazi party, and prominent members of this party. In the early postwar years, a large segment of the industrial sector was nationalized—part was converted into “Soviet joint-stock companies” and part into “people’s companies” (Volkseigene Betriebe)—so that in 1950 nationalized industries accounted for 75 percent of industrial production.27 In agriculture, there was a land reform in 1945 in which farms of 100 hectares and more were expropriated, followed by collectivization in 1952–60 that resulted in the nationalization of 90 percent of all arable land. The process of nationalization was completed in 1972 with the incorporation of the remaining private or semiprivate industrial enterprises into the sector of state-owned companies. Thus, in 1988, virtually all industrial employment was accounted for by the state sector (Table A13). Similarly, almost all transportation companies, banks, and insurance companies had been nationalized. In the agricultural, construction, and retail sectors, there was a mixture of state and cooperative ownership; the latter, however, did not entail any private ownership rights for the members of the cooperative. Only in the handicraft and housing sectors was there still considerable private ownership; about 72 percent of the labor force in the handicraft sector worked in private companies and a significant part of the existing housing stock was in the hands of private owners.28 However, private ownership was predominant in the prewar housing stock, while most new residential structures were owned by the State.

Public ownership of the means of production was considered by the SED to be the most important element of the economic system and was guaranteed in Article 9 of the GDR Constitution.29 In Article 10, socialist ownership was defined to comprise public ownership, common property of cooperatives, and property of “certain groups of society” (i.e., political parties and social and cultural bodies). Public ownership was never seen as entailing any property rights for individuals. Public ownership rights lay exclusively with the State, which meant in effect the top echelons of the SED and the government bureaucracy. This dogmatic approach to the question of ownership explains why the GDR Government consented so late—much later than, for example, Hungary or Poland—to joint ventures, and why—under the Modrow Government—private participation in enterprises was limited to 49 percent.

Private ownership was essentially confined to smallscale retail businesses, restaurants, and craft shops. Private companies were permitted to exist only if they were “predominantly based on personal labor” (Article 14(2) of the Constitution). According to official statistics, private businesses produced less than 4 percent of NMP in the 1980s. They faced extremely unfavorable conditions, including very high marginal tax rates and frequent changes in regulations.

The most fundamental difference between a centrally planned and a market economy is the distribution of property rights. It is, therefore, not surprising that privatization of state-owned property turned out to be one of the most contended issues in the reform of the GDR’s economy. Although private property rights were mentioned in Chapter I of the State Treaty as one of the principles on which GEMSU was based, the treaty was rather short on the specifics of privatization. Appendix IX to the treaty stipulated only that the GDR would ensure a sufficient supply of land for private investors and that the assets of the state-owned enterprises that were to be transformed into joint-stock companies would include the land they occupied. In order to clarify the position, the Governments of the FRG and the GDR subsequently published an additional agreement on the principles of privatization and the Volkskammer of the GDR passed a law on the privatization and reorganization of state-owned property (Treuhandgesetz).

The agreement between the two Governments stipulated that the following principles would guide the privatization process.

  • Expropriations undertaken by the Soviet Military Government in 1945–49 would not be reversed, but an all-German parliament would have the right to determine appropriate compensation.

  • Expropriated or state-administered land and real estate would in principle be returned to the previous owners or their heirs.30 If, however, land or real estate had been used for other than its original purpose and could not be returned, compensation would be paid. This applied also to cases where the property has been legally acquired in good faith by citizens of the GDR.

  • Companies or participations expropriated after 1949 would, in principle, be returned to their previous owners. For companies expropriated between 1949 and 1972, compensation might be paid in lieu of restoration of ownership rights.

  • The GDR authorities would establish an extrabudgetary fund to finance compensation payments.31 Applications for the return of property or compensation would have to be submitted within a time period to be specified; this deadline would be no later than six months after the effective date of GEMSU. The authorities would ensure that no land or real estate, the property rights to which were unclear, would be sold before the expiration of the application period.

The modalities of the privatization of state-owned enterprises were regulated in the Treuhandgesetz, which went into effect on July 1 together with the State Treaty.32 Under this law, state-owned enterprises were transformed into joint-stock or limited liability companies and a public trust fund for the administration of state property (Treuhandanstalt) took temporary ownership. The Trust Fund was established as a public corporation under the supervision of the Prime Minister of the GDR.33 Its objective was to create competitive enterprises and to privatize them. The State Treaty stipulated that revenue from privatization was to be used primarily to restructure the state-owned enterprises; it might also be used to improve the financial position of the Government and to cover operational expenses of the Trust Fund.34 Should any assets remain after the needs of the ailing enterprises and the budget had been satisfied, they could be used to compensate those GDR citizens whose savings had been devalued by the currency conversion.

The Trust Fund was to conduct the privatizations through a family of smaller funds to which it would transfer ownership rights in the joint-stock and limited liability companies.35 The funds were to be responsible for the closing or restructuring and privatization of the companies in their portfolio, and they were required by the law to take their decisions on the basis of economic considerations, with advice from banks and management consultants.

Price Reform

In the central planning system of the GDR, prices served several purposes. First, they were used as a unit of measurement in the plan; second, they were used to set economic incentives; and third, they served as instruments for changing the distribution of income. Prices did not reflect relative scarcities and were not meant to do so. In principle, factory prices were established by production costs and a markup, while deviations of retail prices from the factory prices for consumer goods were financed through the government budget. Thus, prices in the GDR would not have differed much from what would have resulted in a market economy if costs had reflected relative scarcities of the inputs into the production process and indirect taxes and subsidies had been of a moderate size and structured rationally. In practice, however, factor costs were not aligned with shadow prices. In general, capital was underpriced—the basic interest rate on credits to enterprises was 5 percent (Table A14)36—and profit margins were set to reward socially desirable production. Similarly, since wages were fixed primarily with a view to social considerations, the wage costs embedded in the factory price tended not to reflect the scarcity value of different skills and wage differentials were narrow (see Table A1). In particular, manual labor tended to be overvalued and other labor undervalued.

Since the factory prices resulting from these costs and markups did not in general coincide with the politically desired final sales prices, there was an elaborate system of product-specific taxes and subsidies. In 1988, product taxes amounted to M 43 billion (16 percent of NMP) and product price subsidies to M 50 billion (18½ percent of NMP). Of the latter, M 32 billion (12 percent of NMP) was used to subsidize agricultural products.

The size of subsidies for food products resulted from the extraordinarily high agricultural producer prices. In the 1980s, the level of agricultural producer prices far exceeded that in the FRG. This reflected the greater emphasis put on price policy as a tool to influence production in the agricultural sector than in other sectors of the economy and was justified by the high costs and low yields of east German agriculture. Agricultural price policy was also guided by the objective of equalizing living standards of the rural and urban population.

As a result of currency union and price reform, the FRG’s price structure emerged for all traded goods. Initial distortions, in the form of excessive prices for a number of Western goods in certain areas of the GDR, were eliminated quickly through competition. The system of taxes and subsidies also came into line with that of the FRG, with the exception of rents, household energy use, and public transport. Subsidies in these latter areas will be reduced, starting in 1991.37

Monetary Reform

According to socialist economic theory, a one-bank system is desirable for a centrally planned economy. Although the GDR never fully reached this “ideal,” the state banking monopoly and the dominant position of the State Bank ensured that banking activities were tied into the system of planning that governed the real economy. The State Bank acted as the central bank of the GDR, as a commercial bank for industry, construction, wholesale and retail trade, transportation, and tourism, and as the bank of the Government. In this latter function, the State Bank automatically financed the government budget deficit. Special banks for agriculture and the food industry and for foreign trade, a cooperative bank for small businesses, and a large number of postal and savings banks all fell under the direct control of the State Bank.

There was no money or capital market in the GDR. Credit and interest rates were used solely as central planning instruments. Bank credit to enterprises was regulated according to administrative credit plans. To facilitate fulfillment of these plans, enterprises were obliged to hold accounts with specific banks. Payments between enterprises had to be effected through transfers so as to minimize the need for cash.

Interest rate policy, which was introduced as an important economic lever during the reform period of the 1960s, retained its role as an instrument of indirect control of business activities in the 1970s and 1980s: interest rates were a cost element in the determination of prices; they were used to evaluate investment projects; and enterprises had to pay “punitive” interest rates when they ran arrears on loan repayments (see Table A14). However, while higher interest payments reduced company profits and hence payments of wage premiums to managers and workers, the lack of an effective threat of bankruptcy38 limited the use of interest rates as an instrument of control.

While it was relatively easy to control credit developments, influence on private holdings of cash was much more difficult. A monetary overhang appears to have accumulated during periods when the central plan forced growth of capital goods at the cost of consumer goods, resulting in an excess demand for consumption goods. Because of the rigid consumer prices, the overhang of purchasing power did not produce open inflation.

The problem of a monetary overhang can be illustrated by the developments of a number of economic indicators during the 1960–88 period. First, the share of cash in total money (consisting of cash and savings deposits) fell during this period by 11 percentage points to 9½ percent (see Table A2). Second, the velocity of money (defined as the ratio of disposable income to money) declined by two thirds,39 from over 2½ to less than 1, largely on account of the rise in savings deposits.40 Third, the household savings rate rose markedly. Thus, past efforts to eliminate the overhang had not been completely successful.41 The actual amount of the overhang that existed prior to GEMSU is difficult to estimate since it depended on the (unknown) velocity of money that would have existed in a market system.42 It seems likely, however, that the overhang was eliminated by the terms of the currency conversion.43

Chapter II of the State Treaty on GEMSU spelled out the terms of currency union and monetary reform in the GDR. All responsibility for monetary policy in the union would be with the Deutsche Bundesbank and the Government of the FRG would remain the sole issuer of coins. In order to create the conditions necessary for an effective conduct of monetary policy, the GDR would introduce a market-oriented credit system and reform the commercial banking system. Regarding the terms of currency union, which was to take effect on July 1, 1990, the State Treaty stipulated that

  • wages, salaries, scholarships, rents, and leases, as well as other recurrent payments would be converted at parity into deutsche mark;44

  • all other claims and liabilities would, in principle, be converted at a rate of M 2 = DM 1;

  • permanent residents of the GDR could, however, exchange at parity the following amounts:45 under 14 years of age up to M 2,000; between 14 and 58 years of age up to M 4,000; and above 58 years of age up to M 6,000;

  • deposits of nonresidents that existed on December 31, 1989 would be converted at M 2 = DM 1, while deposits made at a later date would be converted at M 3 = DM 1;46

  • all businesses would, in due course, issue an opening balance sheet in deutsche mark.

The terms of the currency conversion implied that on average the assets of the banking system (consisting mainly of claims on Government, enterprises, and the housing sector) were converted at a less favorable rate than the liabilities (consisting mainly of deposits by the Government, enterprises, and private households, as well as foreign liabilities and equity).47 The State Treaty therefore foresaw allocation to the banking system of claims on a newly established equalization fund (Ausgleichsfonds).48 Net liabilities of this fund were to be balanced by claims on the GDR Government. The total amount of equalization claims would be determined by (1) the conversion of the book values of banks’ assets and liabilities at conversion day; (2) any devaluation of the converted assets that might become necessary after the establishment of deutsche mark opening balance sheets of businesses; and (3) any additional amounts needed to ensure appropriate capitalization of banks.

The conversion of banks’ assets created a rather arbitrary distribution of debt between the Government and the enterprise sector and among enterprises. In the past, enterprises often borrowed on behalf of the Government or for purposes unrelated to their main activities. As a consequence, government debt was relatively light after conversion, while enterprise debt was rather heavy. A future reallocation of debt from enterprises to the Trust Fund or the Government is therefore likely to take place in cases where enterprises suffer from an undue debt burden and in cases of bankruptcy.49

Reform of the External Trade System and Structural Adjustment

Consistent with the principle of central planning, external trade was subject to a state monopoly by constitutional law.50 Monopoly power was traditionally exercised by the Ministry of Foreign Trade and its subsidiaries, although it was weakened in the 1980s with the Ministry of Foreign Trade having to share control over exports and imports with the Kombinate.51 Foreign trade activities were assigned to special foreign trade companies (Aussenhandelsbetriebe). Detailed plans determined domestic prices and quantities of exports and imports. In addition to domestic requirements,52 obligations vis-à-vis the other CMEA countries, in particular the U.S.S.R., had to be taken into account.

Trade with Western economies took place mostly under bilateral treaties at world market prices. Prices in trade with CMEA countries were, in more recent years, linked to developments in world market prices, albeit with significant lags. Intra-German trade was subject to a special treaty (Berliner Abkommen 1951, which was revised in 1960), which stipulated lists of products that could be exchanged, as well as the modalities for payment. As a rule, only goods of German origin could be traded; prices were market prices in deutsche mark; valuation was, however, in conversion units (Verrechnungseinheiten) each equivalent to one deutsche mark; and payments were effected through accounts at the Deutsche Bundesbank and the State Bank. Under the Berliner Abkommen, there was an interest-free overdraft facility (the “Swing”) with a limit that was adjusted from time to time; between 1986 and 1990, it amounted to 850 million conversion units.

Chapter III of the State Treaty on GEMSU abolished the arrangements for intra-German trade and introduced a free external trading system in line with regulations of the European Community (EC). Existing contracts and trade relations with CMEA partners were, however, given special protection. In the area of agricultural production and trade, the GDR would adopt a price support scheme in line with the EC’s Common Agricultural Policy. In trade of agricultural products between the two German economies, quantitative restrictions would be allowed until the full integration of the GDR’s agricultural sector into the EC market.53 The GDR was also given authority to support structural adjustment of enterprises during the transition to a market economy.54

Reform of the Fiscal and Social Security System55

As explained above, the public sector was in effect the owner of most of the national capital stock. As a consequence, government revenue and expenditure were dominated by transfers to and from industry and agriculture. In 1988, about one third of total expenditure was accounted for by transfers to these sectors that included, inter alia, production subsidies and reinvested profits of the state enterprises (see Table A4). A considerable part of the remaining expenditure was devoted to social purposes, in particular to social security (20 percent of the total) and to consumer price subsidies (18½ percent). As the most important landlord in the country, the Government also allocated 11 percent of its expenditure to housing. Revenue was largely determined by transfers from industry and agriculture, accounting for more than three fourths of the total in 1988. Social security contributions and taxes each accounted for about 7½ percent of total revenue.

Direct taxes in the GDR consisted essentially of taxes on labor income (wage and social security taxes) and, to a rather limited extent, on income from small private companies and self-employment (company taxes). The top marginal tax rate on labor income (20 percent) was much lower than in the FRG (where the top rate was reduced from 56 percent to 53 percent in 1990). Moreover, it was only levied on regular wage income, while supplementary payments and premiums were tax free. Thus, in 1988 wage taxes accounted for only 8½ percent of gross income of wage earners (compared with 14½ percent in the FRG). Social security contributions from wage earners accounted for another 7 percent of gross wage income (12 percent in the FRG), bringing the total average direct tax burden to 15¾ percent (26½ percent in the FRG). Company taxes were highly progressive with top rates reaching 90 percent for all companies and for the self-employed who did not benefit from preferential tax rate schedules.56

Chapters IV and V of the State Treaty on GEMSU contained stipulations breaking down the existing public sector into the territorial authorities, the social security system (consisting of pension, unemployment, health, and accident insurances), and private and public enterprises (e.g., railways and the postal system). These chapters also stated that, with a view to promoting social union, the social security system of the FRG be introduced in the GDR. Thus, regulations for unemployment compensation and pension payments were to be harmonized with those in the FRG;57 the generous special social benefits previously granted to GDR immigrants by the FRG were eliminated shortly before GEMSU became effective.58 In the area of health insurance and services, a gradual transition to the FRG system and standards was envisaged. Contributions to the social security system were introduced at the same rates as in the FRG.

Regarding fiscal reform, the expenditure and revenue side of the GDR Government accounts were to be completely restructured. On the expenditure side, the budget would be substantially reshaped by the altered relationship between the Government and the enterprises and by the elimination of most consumer subsidies. On the revenue side, the State Treaty stipulated the adoption of the tax system of the FRG by the GDR. Indirect taxes were to be introduced on July 1, while the full system of direct taxes would be introduced in January 1991. For the second half of 1990, a simplified system of income and corporate taxation was adopted.59

In addition to specifying expenditure and revenue reforms, the State Treaty on GEMSU provided a financial framework for fiscal policy in the GDR in 1990 and 1991, in the form of borrowing limits for the GDR Government and provision for fiscal transfers from the FRG to the GDR. This framework was, however, overtaken by events, as the much weaker-than-expected economic situation in east Germany in the second half of 1990 was reflected in the government finances and the earlier-than-expected political union fundamentally changed the institutional framework. As far as central government functions are concerned, they have been absorbed, from October 3, 1990, by the federal government budget, and the new Länder and the local authorities in the eastern part of Germany will have their own budgets. Recent budgetary developments in east Germany are discussed in Chapter XI

Appendix I

Statistical Tables

Table A1.

German Democratic Republic: Average Monthly Gross Wage Income by Sector

(In marks)

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Source: Statistisches Bundesamt, DDR 1990–Zahlen und Fakten, 1990.


Table A2.

German Democratic Republic: Income and Money in Circulation

(In millions of marks)

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Source: Staatliche Zentralverwaltung für Statistik der DDR, Statistisches Jahrbuch der DDR 1989; and Statistisches Bundesamt, DDR 1990–Zahlen und Fakten, 1990.

Excluding deposits of Government and enterprises and life insurance deposits of private households.

Disposable income divided by money.

Table A3.

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

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Source: Deutsche Bundesbank.
Table A4.

German Democratic Republic: Government Revenue and Expenditure

(In billions of marks)

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Source: Staatliche Zentralverwaltung für Statistik der DDR, Statistisches Jahrbuch der DDR, 1989.
Table A5.

German Democratic Republic and Federal Republic of Germany: Consumption of Private Households, 1985

(In percent of total)

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Source: Deutscher Bundestag, Materialien zum Bericht zur Lage der Nation im geteilten Deutschland 1987, 1987, p. 510.
Table A6.

German Democratic Republic: Purchasing Power of the Mark

(Purchasing power of the deutsche mark = 100)

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Source: Deutscher Bundestag, Materialien zum Bericht zur Lage der Nation im geteilten Deutschland 1987, 1987, p. 517.

End 1972–beginning 1973.


Table A7.

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

(In billions of marks)

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Source: Staatsbank, Jahresbericht 1989, March 1990.

Of this, M 10.4 billion were used for public construction (hospitals, schools, kindergartens, etc.).

Of this, M 90.7 billion were in savings accounts, M 69 billion in sight deposits, and M 14.7 billion in term deposits.

Of this, M 31.9 billion were loans to the Government. The remainder reflected shares and participations of the State Bank in public property.

RIKOs (Richtungskoeffizienten) reflect the cumulated balance of the special fund described in footnote 18.

Table A8.

German Democratic Republic: External Trade1

(In billions of valuta mark)

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Source: Staatliche Zentralverwaltung für Statistik der DDR, Statistisches Jahrbuch der DDR, 1989.

Trade data of the former GDR substantially underestimated trade with non-CMEA countries. Accordingly, it is likely that these data will be revised.

Table A9.

German Democratic Republic: External Trade with IMF Member Countries

(In millions of U.S. dollars)

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Source: International Monetary Fund, Direction of Trade Statistics.
Table A10.

German Democratic Republic: External Trade by Major Products

(In percent of total)

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Source: Staatliche Zentralverwaltung für Statistik der DDR, Statistisches Jahrbuch der DDR, 1989
Table A11.

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

(In billions of deutsche mark)

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Source: Deutsches Institut für Wirtschaftsforschung, DDR—Wirtschaft im Umbruch, 1990.

Includes capital transfers to improve traffic with Berlin, reimbursement of visa fees, etc.

Table A12.

Balance of Payments of the Federal Republic of Germany with the German Democratic Republic

(In billions of deutsche mark)

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Source: Deutsche Bundesbank, Monthly Report, January 1990.


Minus sign indicates deficit of the FRG.

Table A13.

German Democratic Republic: Employment1 by Sector and Type of Ownership, 1988

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Source: Staatliche Zentralverwaltung für Statistik der DDR, Statistisches Jahrbuch der DDR, 1989.

Including apprentices.

Table A14.

German Democratic Republic: Interest Rates as of End-1989

(In percent)

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Source: Deutsches Institut für Wirtschaftsforschung, DDR-Wirtschaft im Umbruch, 1990.

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

The constitution of the GDR (Article 9) mandated a socialist planned economy. Accordingly, production, employment, investment, price formation, money and credit creation, and, though less directly, private consumption, were in one way or another subject to central planning. The approach to central planning in the GDR was changed on several occasions because of dissatisfaction with the results. These changes manifested themselves in the relationship between the command and the operational spheres of the economy. Broadly, three phases can be identified:

  • strict central planning (1945–62)

  • reform period under General Secretary Ulbricht (1963–70)

  • recentralization under General Secretary Honecker (1971–89)

Central planning in the first phase was very crude, with complete dominance of the command sphere. Production, distribution, and investment at the plant level were controlled directly and output volumes were specified in detail. Capital investment, particularly in heavy industries took precedence over satisfying consumer demand. This rigid approach to planning led to severe difficulties resulting in low economic growth, pervasive bottlenecks, and structural imbalances between supply and demand1 and triggered a comprehensive reform of the planning system in the early 1960s.2 The new economic system (Neues Ökonomisches System der Plannung und Leitung der Volkswirtschaft or NÖS) was adopted by the Ministerial Council in 1963. Its main characteristic was a partial shift of responsibilities from the command sphere to the operational sphere, giving companies more freedom in decision making. So-called “economic levers” (Ökonomische Hebel) were introduced, reducing substantially the number of quantitative indicators and targets. Profitability and premium wages were given greater emphasis. In addition, a price reform was carried out, starting with capital goods prices and later extending to inputs for industry. The prices of consumer goods, however, were adjusted only to a small extent, because stable consumer prices remained an important political objective. The measures adopted were, however, partial, and following some early successes of the economic reform program, severe difficulties reemerged in the late 1960s.

Under a new party leader, Erich Honecker, the eighth party congress of the SED brought the reform era to an abrupt end and shifted economic policy back to a more direct system of central planning. Under external pressures (oil price shocks in 1973 and 1979 and a dryingup of credit from Western banks in 1982), this system was modified several times, and some elements of the earlier reform program were reintroduced. In particular, the system of targets and indicators was changed frequently. In 1984, net profits and other efficiency criteria were again used as important measures of company performance. The principle of “creating own funds for investment” was revived, giving back to companies some freedom in making independent investment decisions. Frequent attempts were also made to improve the functioning of the rigid price system.3 Success was limited, however, because of the partial nature of the reforms. For example, in 1979–80 many smaller and medium-sized companies with similar production and marketing characteristics were merged into the so-called Kombinate in order to facilitate central planning and control.4 The return to the strict command economy in the early 1970s followed by the subsequent partial reintroduction of reform elements was not successful: the gap in living standards between east and west Germany widened further, sowing the seeds for the demise of central planning at the end of the 1980s.


A chronology of recent events is provided in Box 1.


See Chart 1 in Chapter II and the accompanying text.


The enlarged cabinet consisted of 16 communist party members; 11 members of the so-called block parties (the previously existing parties, i.e., the Christian Democrats (CDU), the Liberal Democrats (LPDP), the National Democrats (NPDP), and the Farmers’ Party);and 8 new ministers without portfolio from eight newly formed opposition groups, including the Social Democratic Party, the Democratic Awakening, and the New Forum.


Sections I and II of the Unification Treaty laid out the principles under which political unification would take place. Section II also contained a set of rules that would initially govern the system for allocating revenue among the federal and state governments. The implications of unification for domestic laws and international treaties were spelled out in Sections III and IV. Matters concerning public administration, especially those relating to the administration of the states, were covered in Section V. Section VI contained the principles under which public assets and liabilities would be administered. A variety of other issues, including labor laws, social welfare, and science and education policies were dealt with in Sections VII-IX.


Brandenburg, Mecklenburg-West Pomerania, Saxony, Saxony-Anhalt, and Thuringia.


Value added in the banking, insurance, professional services, and government services sectors is not included in NMP. Recent figures published by the Statistical Office of the GDR put net domestic product at M 294 billion in 1988, compared with M 268 billion for NMP, reported in the GDR Statistical Yearbook for 1989.


This is apparent even from official data: use of NMP (for either consumption or investment) grew at a rate of a little over 2 percent in 1980–88, some 2 percentage points less than the growth of production, implying a substantial terms of trade loss.


For example, in the “Economic Strategy for the 1980s,” adopted at the tenth Party Congress of the SED in 1981, microelectronics was singled out as a high-priority investment sector.


In automobile production, for example, many machines predated World War II. The highways and the rail system were in poor repair and the telecommunications system was outdated. Overall, the capital-output ratio—according to official data—exceeded 4.5, a value much higher than in the FRG or other Western industrial countries.


The lignite found in east Germany has a large sulfur content which, because of insufficient filtering, causes severe air pollution in the process of generating electricity. Power plants are inefficient and subsidization of electricity at the producer and consumer level has encouraged waste.


Reported in Deutscher Bundestag, Materialien zum Bericht zur Lage der Nation im geteilten Deutschland, 1987, November 1987. Estimates based on output per working hour tended to show a gap a couple of percentage points larger, as hours worked per worker are higher in the GDR compared with the FRG.


See Deutsches Institut für Wirtschaftsforschung, Wochenbericht 26/90 (Berlin), June 28, 1990, pp. 341–56. GDP per employed person was estimated at about 40 percent of the west German level.


See Deutsches Institut für Wirtschaftsforschung, Wochenbericht 14/90 (Berlin), April 5, 1990, pp. 172–74.


See Deutsches Institut für Wirtschaftsforschung, Wochenbericht 26/90 (Berlin), June 28, 1990, pp. 341–56.


In 1988, the take-home pay in the GDR and the FRG averaged M 925 and DM 2,070, respectively.


Rents were kept artificially low—in 1985 a new two-room efficiency apartment cost only M 75 a month, compared with DM 390 in the FRG—but the housing stock was old and deteriorating. In 1989, about 26 percent of apartments and houses did not have an indoor toilet and 19 percent did not have a bath or a shower. More than half of the apartments and houses were built before 1945 and about one third were built before 1919. See Ifo Institute, Schnelldienst (Munich), Vol. 43, No. 15 (May 21, 1990), pp. 9–25.


Price increases because of improvements in quality do not enter inflation calculations.


In order to reconcile the official exchange rate with that for external trade, a special fund (Rückstellungen für Richtungskoeffizienten or RIKO fund) was established at the State Bank. When goods worth DM 100 were exported to the convertible currency area, the exporter obtained the equivalent valued at the external trade exchange rate, for example, M 440 if the transaction took place in 1989. Of this, he received M 100 (the value of the exports at the official exchange rate) directly from the foreign trade company responsible for the transaction and the balance (i.e., M 340, if the transaction took place in 1989) from the special fund. Similarly, an importer importing goods worth DM 100 paid M 100 to the foreign trade company and M 340 to the special fund. See also the discussion in Chapter X, section on “Mechanics of the Conversion.”


The transferable ruble is the common unit of account used by the International Bank for Economic Cooperation (IBWZ) of the CMEA countries. The foreign currency value of the transferable ruble is determined through a currency basket that contains the currencies of the major Western trading partners of the CMEA countries. The exchange rate of the transferable ruble is regularly adjusted by the IBWZ.


The tourism rate applied without limitation to purchases of marks. In the first half of 1990, sales of marks by GDR residents were limited to M 200 a year (M 100 for children) and were subject to two exchange rates. Half of the total amount could be exchanged into deutsche mark at parity and the other half at DM 1 = M 5. To maintain the official rate, a currency fund of DM 2.9 billion was established with contributions from the FRG and the GDR amounting to DM 2.2 billion and DM 0.7 billion, respectively.


In part, this debt reflected credit extended by the State Bank to the Government, as a result of the need to replenish the RIKO fund (described in footnote 18) after devaluations of the commercial rate of exchange between the mark and the valuta mark that applied in trade in convertible currencies.


The foreign currency value of these assets is difficult to establish since they were presumably denominated in nonconvertible currencies.


In May, wages in industry were 17 percent higher than in May 1989.


Measured inflation rates in the GDR in the initial months of GEMSU have to be interpreted carefully because of difficulties in allowing for the sharp shift in the availability and quality of goods.


The ZK, whose members were elected by the party congress, acted as the legislative and executive body of the SED. Its day-to day operations were conducted by the so-called Secretariat (Sekretariat des ZK der SED). The ZK elected the members of the Politburo who formed the most powerful group within the SED.


Formally, the Planning Commission had the rank of a ministry. In addition to the preparation of economic plans, the Planning Commission was responsible for the analysis and projections of economic developments and the control and supervision of other planning institutions, for example, the planning commissions of the regional and local levels of government. Under the Modrow Government, the planning commission became the economic commission, but its function remained essentially unchanged.


A large part of the assets of Soviet joint-stock companies was transferred to the U.S.S.R. as war reparations. The remainder was returned to the GDR in 1952–53, in part against payment. See Deutsches Institut für Wirtschaftsforschung, Handbuch DDR Wirtschaft (Berlin, 1985).


In 1989, 19 percent of apartments and 87 percent of one- and two-family houses were privately owned. See Ifo Institute, Schnelldienst (Munich), Vol. 43, No. 15 (May 21, 1990), pp. 9–25.


Constitution of 1968 as amended in 1974.


This stipulation was later found to be one of the major deterrents to private investment in the GDR. In the Unification Treaty it was changed so as to limit claims of previous owners to monetary compensation.


It has been suggested that this fund be financed from revenue derived from privatization.


Agriculture and forestry were covered by separate regulations that took account of the specific characteristics of these sectors.


It was to be headed by an executive board (Vorstand) consisting of a president and four directors, who were to be appointed by the supervisory council (Verwaltungsrat). The latter would monitor and support the operations of the board of directors. The supervisory council would consist of a chairman and 16 members. The chairman and seven council members were to be appointed by the GDR Government and the remaining members by the GDR parliament.


Originally, the Trust Fund was given authority to borrow DM 7 billion in 1990 and DM 10 billion in 1991 in anticipation of revenues from privatization. Later, in the Unity Treaty, the borrowing authority was raised to DM 25 billion in 1990–91.


Allocation of shares would be determined by the supervisory council of the Trust Fund.


In addition, interest subsidies and surcharges were used to orient investment decisions toward the objectives of the plan.


Rents in the GDR were so low that they did not cover capital and maintenance costs of the housing stock. The State Treaty on GEMSU, however, foresaw that rents would increase in line with wages and salaries so that these costs would gradually be taken over by the private sector. It has already been announced that rents are to double at the beginning of 1991. In cases of social hardship, there will be direct income support from the Government.


Enterprise losses were financed through bank credit or out of the government budget. There was never an effective bankruptcy threat for any of the state-owned companies.


By comparison, the velocity of broad money in the FRG declined by only one third during the same period, despite a much more rapid expansion of the range of financial instruments.


The velocity of cash in circulation declined by only 18 percent during this period.


In 1967, the overhang was reduced by a forced cut in private cash holdings (a mini currency reform).


See Chapter X, section on “The Implications of the Conversion Rate.”


On the basis of deposits at the end of May, the terms for currency conversion (see text below) reduced the amount of cash and sight and savings deposits held by households by 32 percent from M 182 billion to the equivalent of M 123 billion (evaluated at parity between the mark and the deutsche mark). See Chapter X for further discussion.


For wages and salaries, contractual payments in effect on May 1, 1990, were used as the base for the conversion.


The State Treaty allowed for the possibility, sometime in the future, of compensating those whose savings were devalued with proceeds from the privatization of previously state-owned enterprises.


The mark was devalued to M 3 = DM 1 with effect from January 1, 1990 and it was presumed that financial transactions of nonresidents after that date took account of the new official exchange rate.


Preliminary calculations on the basis of data as of May 30, 1990, indicated that the converted assets of the banking system would fall short of liabilities (including equity) by some DM 26 billion, allowing a conversion rate for equity of M 1 = DM 1. See Chapter X, section on “The Mechanics of the Conversion” for further details.


When after conversion the assets of a bank exceeded its liabilities (including equity), the equalization fund received a claim in that amount on this bank. Interest on equalization claims was set at the three-month Frankfurt interbank offer rate (FIBOR).


Since the Trust Fund, as a public corporation, is backed by the Government, there is little difference between the two alternatives.


Article 9(5) of the 1968 Constitution.


Kombinate were large conglomerates. Their creation is described in Appendix II.


The GDR economy depended on raw materials and energy imports from the U.S.S.R. and on imports of technologically advanced products from the industrial countries.


In midyear, the GDR introduced a system of import prohibitions and quotas for a range of agricultural products. The FRG abolished export restitution payments and import levies in agricultural trade with the GDR, but left quotas on imports intact. Subsequently, restrictions on agricultural trade between the FRG and the GDR were abolished.


The GDR Government decided to give financial support to investors in the amount of 12 percent of investment undertaken between July 1, 1990 and June 30, 1991 and 8 percent of investment undertaken between July 1, 1991 and June 30, 1992. In addition, since political unification, regional assistance premiums have been available for investment in the former area of the GDR under the regional policy program of the FRG. Premiums granted under the two schemes cannot, in sum, exceed 33 percent of the investment expenditure. However, investment spending in the east benefits in addition from special depreciation rates that allow write-offs of 50, 30, and 20 percent, respectively, in the first, second, and third year of the investment.


A more detailed description is provided in Chapter XI


Preferential tax treatment was given to several groups of selfemployed. Highly preferential rates applied to scientists, artisans, and writers (with a top marginal rate of 30 percent). Other groups benefiting from preferential rates were other professionals (top marginal rate of 60 percent) and retail traders (top marginal rate of 70 percent).


Unemployment benefits would amount to 65 percent or 68 percent of net wages in previous employment, depending on the marital status of the worker. After 45 years of work, pensioners would receive, on average, 70 percent of the average GDR net wage.


These benefits included special assistance in finding jobs and housing as well as settling-in grants. In addition, GDR immigrants had full access to the FRG’s social security system as if they had paid regular contributions.


In the second half of 1990, wage taxes were to be levied on the basis of Tax Class I of the west German tax code which normally only applies to unmarried persons without children. Companies were to pay taxes according to the GDR tax code for the remainder of the year.


Economic difficulties had been exacerbated by the mass exodus of GDR citizens to west Germany before the erection of the Berlin wall in 1961 (see Chapter VIII for details), frictions in intra-German trade relations, and a bad harvest in 1961.


Interestingly, the reform movement began in the U.S.S.R., spurred by a series of articles in Pravda. General Secretary Ulbricht propagated these ideas in the GDR and the SED Politburo adopted them in 1962. The sixth party congress of the SED accepted a comprehensive economic reform program in 1963.


In June 1976, industrial producer prices were adjusted in the wake of the first oil price shock and new rules for determining consumer prices were introduced (constant prices for basic goods; cost determined prices for more advanced products). In the 1984 reform of agricultural prices, the principle of cost determined prices was extended to agriculture. Also in 1984, pricing rules for new products were introduced and a new price system for capital goods was initiated.


In 1988, there were altogether 173 centrally controlled and 143 locally controlled Kombinate, which together accounted for close to 50 percent of overall employment in the GDR. The majority of enterprises merged into the Kombinate (about 60 percent) were small and medium-sized companies (up to 500 employees); only 21 enterprises with more than 10,000 employees were part of the mergers.