Privatization in East Germany
A Survey of Current Issues
  • 1 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund

This paper deals with the privatization, restructuring, and liquidation of East German industrial firms. A partnership model is suggested for privatization where the Government’s property trust (Treuhandanstait (THA)) is made a silent partner of the private investors. The application of a general scheme of wage subsidies is rejected in the paper. Furthermore, the paper argues against restructuring policies of the Government’s property trust and proposes to set decreasing limits on the trust’s finances for the years following 1993. The decreasing financial inflow will force the Government’s trust to close firms, and will also signal the commitment of the Government to liquidate the trust itself by, say, the year 2000.

Abstract

This paper deals with the privatization, restructuring, and liquidation of East German industrial firms. A partnership model is suggested for privatization where the Government’s property trust (Treuhandanstait (THA)) is made a silent partner of the private investors. The application of a general scheme of wage subsidies is rejected in the paper. Furthermore, the paper argues against restructuring policies of the Government’s property trust and proposes to set decreasing limits on the trust’s finances for the years following 1993. The decreasing financial inflow will force the Government’s trust to close firms, and will also signal the commitment of the Government to liquidate the trust itself by, say, the year 2000.

I. Which Current Issues?

The transition of the industrial sector from planning to market orientation is one of the central problems facing East Germany after the German unification. The industrial sector has to be completely rebuilt and privatization of viable firms is as important a step in this progress as the liquidation of nonviable firms. All these problems have intensively been discussed in all post-communist states. It is quite important always to keep in mind the particularities of the German situation. These particular features explain why policies which may be adequate for, say, Czechoslovakia, might not be recommendable for East Germany. Hence, this paper begins with highlighting the economic and institutional background of the East German transition (Section II).

Then we turn to the transition itself. Currently, privatization in East Germany is performed by a government property trust (Treuhandanstalt (THA)), which has opted for a policy of rapid privatization by low-price sales of industrial firms to those investors who present the best business plan with respect to investment and employment. Although in 1991 the sales figures look impressive, one of the current policy issues is how the THA’s procedure can be improved: Should the German policy introduce general vouchers or vouchers for special groups of the population (for instance, for employees)? Should the THA retain part of the shares of privatized companies? Should wages or capital, or both, be subsidized? Many recent proposals referring to these questions were put forward in 1991 and are critically evaluated in Section III of this paper.

Even more important, however, is the issue of what will happen when the successful privatization policy comes to an end because all or most of the attractive firms have been sold. If there are no private bidders for some firms, should the Government (via the THA) restructure this firm? How much restructuring is desired? These issues are treated in Section IV of the paper.

Finally, it is not too early to start thinking about how to end the process of transition. To avoid the nightmare of permanent subsidies, unpopular firm liquidation policies will have to be made. The Federal Government should announce this policy right now as part of a long-term commitment not to allow bailing out of nonviable firms for too long. Some policy suggestions are presented in Section V.

II. East Germany in Transition

1. The economic background

Privatization in Germany is different from that in Czechoslovakia, Hungary, and Poland. In contrast to these countries, it is not the total German economy which is to be privatized, but only part of a large, Western-style economy. Taking 1988 figures, East German employees would have counted for 22 percent of the total East and West German work force. East German disposable income would have counted for only 11 percent of total German disposable income. 1/ A strong economy like Germany’s should be able to cope with even a major depression of, say, a sixth of its economy. Whereas in Czechoslovakia or Poland the total economy is to be restructured, the problem facing the united Germany could better be compared with the problem of restructuring the underdeveloped parts of some countries, like the Mezzogiorno in Italy, or with the problem of revitalizing decaying areas in otherwise flourishing cities.

Being part of the united Germany, the new states and East Berlin enjoy:

(a) The West German system of laws and regulations for both government and business, often difficult to handle, but well-developed over many years of application;

(b) Instant currency convertibility and, by using a currency with a long-standing reputation of stability, guaranteed absence of hyperinflation as a consequence of price liberalization;

(c) The benefits of special recovery programs set up and financed from the West with respect to infrastructure, restructuring of old firms, establishment of new firms, and stimulation of investments;

(d) Access to West German human resources and know-how; West German investors, banks, and insurance companies are available for starting and redeveloping businesses;

(e) The (West) German social security system which is available to pay for the unemployed; and

(f) Direct access to EC markets.

Therefore, East Germany is in a privileged position. Using a “parental guide” model helps explain the transition from a planned to a market economy better than a “help yourself” model, which is applicable to Czechoslovakia, Hungary, Poland, and others.

However, having successful parents constitutes both an advantage and a risk. These risks of a parental-guide situation show clearly in the relation between West Germany as the parent and East Germany as the child. East Germany’s expectations often are excessively high--aiming at the parent’s example--be it the 1:1 conversion of East and West German marks, or the rapid increase in East German wages to reach the West German level in a few years. West Germany, on the other hand, simply having too much money to spend, may bail out nonviable East German firms for too long, where the nonviability is precisely brought about by too high wages which significantly exceed East German productivity. A country like Poland could not afford to pay so high wages and keep the firms alive; hence, they have to accept low wages. Only the rich parent West Germany can opt for a policy of high wages and intense subsidization of nonviable firms. It is the intention of this paper to warn of such a policy which is so costly because it ignores the trade-off between wages and jobs.

The background of such a policy is the special German internal migration problem. There are two types of migration which German policymakers are afraid of: (a) a high unemployment migration, brought about by high East German wages; although the unemployment benefits in this case are high, East Germans seem to be quite sensitive to lasting unemployment in spite of the difficulties they have to face if they move to the West; 1/ and (b) a low wage migration where the wage differentials between East and West Germany are the main driving force; this makes it difficult to adjust the East German wages to the development of labor productivity.

However, any policy of moderate unemployment coupled with moderate wage increases was made impossible by the trade unions who used the argument of imminent high migration to go for a policy of high minimum wages and found no resistance on the employers’ side. 2/ This shifted the responsibility for the employment policy to the Federal Government which, in turn, pushes the THA to rank job preservation quite high on the scale of its objectives.

2. The institutional background

The THA is the trust which owns most industrial enterprises in East Germany. It was founded by the Government of the German Democratic Republic in December 1989, and restructured further in June 1990. Hence, the privatization or restructuring of East German firms started with a government agency in charge of transforming the East German economy from planning to “market socialism”; unlike in Hungary, there was no movement toward “spontaneous privatizations.” Detailed data information on the THA is presented in an appendix to this paper.

Back in 1989 and 1990, a tripartition of the East German industrial firms became popular: (a) one third viable in a market environment; (b) one third viable after restructuring; and (c) one third nonviable. Based on this tripartition, the THA was supposed to immediately privatize the first group, to restructure and then privatize the second, and to liquidate the third. 1/

It is not known where the figure of 33 percent originated, and whether it was ever correct. In any case, it did not come from empirical research. Moreover, the percentages depend on the economic development; in particular, the wage increases in 1990-91 have reduced the first and second groups and enlarged the third. However, for the arguments of this paper, the precise percentages are not important, what matters is the qualitative categorization of THA activities.

This categorization reflects planning under perfect information, where the government agency as a benevolent dictator knows perfectly well which firms are viable in a market economy, how to restructure these firms, and which ones to liquidate.

Soon it became clear that this program was too demanding for a government agency and that political pressures and bureaucratic red tape would interfere with the efficient transition from a state-planned industrial structure to a market-oriented economy:

  • With respect to privatization, THA officials typically do not sell for the highest price set by auction bidding, but instead evaluate the explicit investment and employment plans of potential purchasers. This typically implies a bias in favor of job preservation;

  • With respect to restructuring, as far as the THA operates on the basis of business plans formulated by firms which are candidates for restructuring, industrial structures may become fossilized; and The job-preserving objectives of the THA imply that many firms which should be liquidated are not.

How to improve the THA policies will be shown in the following sections.

III. Privatization

1. Should people’s shares or vouchers be recommended for Germany?

To promote the rapid privatization of as many firms as possible, the application of people’s shares or vouchers has been advocated by many advisors to former communist countries. 1/ The German Federal Government (including the THA) never intended to implement general vouchers or shares. However, several German reform proposals suggest such a scheme, for instance, an October 1991 program of the German trade union of the metal workers and the reform model of G. and H.-W. Sinn (1991). In practice, Czechoslovakia is the first country to apply such a scheme, 2/ with other countries to follow. Only Hungary has shown no interest in such a policy.

This is not the place to repeat the details of the various proposals put forward in theory and in practice. 3/ The basic idea is that the publicly owned firms should not be sold to private bidders, but that they should be given away to the adult population either free of charge or at a very low price. The general population either gets shares or vouchers which at some later point in time can be exchanged for shares. If a direct ownership program is intended, the publicly owned firms must be converted to joint stock companies and the general population entitled to the property rights of the firms (directly via shares or indirectly via vouchers). 4/ If 100 percent of the entitlements are given to the general population, there will be no effective management control, at least not in the short run. Hence, typically, only a smaller percentage is given to the population; the remaining entitlements could, for instance, be auctioned off to private investors (maybe from abroad) in such a way as to achieve effective management control. Alternatively, management control may be achieved by giving part of the entitlements to financial intermediaries or banks or by withholding government participation in the privatized firms. 1/ If an indirect ownership program is planned, the ownership of the firms is transferred--free of charge--from the Government to financial intermediaries, and the entitlements in the intermediaries are distributed to the general public. The intermediaries control the firms, and they themselves should be controlled either by the Government or by competition between them. 2/

Defendants of distributive privatization hint at reasons of justice. 3/ First, granting the same amount of shares or vouchers to every citizen apparently implies an equal distribution. However, this initial equality will not hold for very long if trading in shares or vouchers is initiated. The trading will quickly destroy the initial equality and those who care for end-state equality will not be content with the resulting distribution, wherein speculators will have succeeded in gaining a greater piece of the cake than the proverbial man in the street.

In Germany, moreover, even initial equality is complicated to achieve. It seems evident that only former GDR citizens get vouchers or shares, but not the West Germans. However, it is difficult to determine which qualifying date should be chosen. Should former GDR citizens who left the GDR before the day of unification also be entitled to get vouchers? Certainly not if they fled in, say, 1953. However, what about those citizens who fled between the fall of the Berlin Wall and the day of unification (and, maybe, even returned after unification)? What about those who fled via Hungary in those dramatic days before the fall of the Berlin Wall (after all, it was mainly those refugees who caused the collapse of the hard-line communist regime). Any qualifying date, to be chosen, would be contestable on equity grounds.

There is yet another problem of justice connected with distributive privatization programs. It has been argued that it is equitable to grant explicit ownership of East German firms to the East German population because prior to unification they implicitly owned the firms. This argument accepts as legitimate the people’s property inherited from the communist system and postulates to transfer it into the Western type of individual property. 1/ If such juridical position is taken, as seems to be the case in Czechoslovakia or Poland, it could well constitute the basis for giving away people’s shares of publicly owned enterprises.

However, this has definitely not been the German position. In the treaty on German unity, the original owners whose individual property was expropriated by either the Nazis or the GDR were explicitly entitled to plead for restitution in kind. 2/ The people’s property became extinct on the day of German unity, and only the concept of individual property of the original owners matters from a legal standpoint. If the people’s property is extinct, then it cannot be a legitimate basis for giving away shares or vouchers. Hence, given the position of the treaty on German unity, there is no argument for a general scheme of people’s shares or vouchers in Germany. 3/

Consider the case of a firm originally owned by an East German who is not interested in restitution in kind, but goes for monetary compensation. The THA sells the firm to the entrepreneur who offers the best bid. The original owner then is entitled to receive either the money the THA received from the bidder, or the market value, whichever is higher. This is the way in which East Germans get a share of the new German economy. Restitution in kind is another way which is particularly applicable in those cases of small enterprises which were nationalized in 1972. A general voucher scheme would not fit into such a privatization process. Giving vouchers to these original owners would mean giving to them twice.

East German citizens, however, might argue that it is not enough that the original owners get their property back or get monetary compensation. They might argue that in the forty-odd years since 1949, West German citizens could establish new firms, acquire ownership of shares, etc. This would imply a request by East Germans that financial compensation be paid for lost chances. This argument is plausible and, since everybody has been deprived of the chances, it justifies a general system of compensation.

As could be expected, there are pro- and contra-arguments on the application of general voucher or share schemes for East Germans. I, personally, am not convinced that this is a recommendable policy. First, vouchers or shares are not a good distributive device if one cares for end-state equality and, second, the entitlement of original owners is at variance with an entitlement of the general population. These two arguments convince me to dismiss the idea. However, I can understand how someone could think that general vouchers should be given as financial compensation for forty years of lost chances.

2. Giveaways and the participation model

In most former communist countries there is not enough purchasing power to allow for rapid privatization. Estrin (1991) mentions that “in Poland… savers could purchase approximately 1 percent of the capital stock.” “Czechs could currently purchase 10 percent of the state assets… and at the current rate of saving would take a further 150 years to purchase the whole capital stock.” 1/ Giving away the firms solves the problem of the lack of purchasing power and also allows for a comparatively rapid privatization. In Germany there is more purchasing power than in Czechoslovakia or in Poland. Moreover, it may more easily attract foreign capital. However, even in Germany it is questionable whether it is possible to sell all viable East German industrial firms at a price equal to their estimated value. 2/

Let us next mention the difficulties in evaluating the firms to be sold. Looking at East Germany, this problem is prevalent, given, for instance, the lack of information on ownership or on environmental damages to be covered in the future. The THA deals with these problems in the following way. The agency shares with the investor, or even fully bears, the environmental and ownership risks. It also may enter into some agreement about the servicing of former company debts. The agency sells firms at a low price, sometimes at even DM 1, but coupled with investment pledges and job guarantees (with penalties to be paid by those investors who do not abide by their commitments). This illustrates that the THA is moving toward a policy of giving away the firms to entrepreneurs (and not to citizens or employees and managers, to briefly mention the other possible forms of giveaways).

In the trade-off between speed and transparency of privatization, the THA has opted for speed. This proves advantageous for the transition to a market economy. No time is lost in ensuring that economic decisions are taken by private entrepreneurs. There is already a critical mass of enterprises which have been privatized during the still-prevalent momentum of unification. If the privatization process should take too long, bureaucratic hierarchies in the THA enterprises would take command and it would prove most difficult to transform these bureaucrats into Western-type managers and employees. Unfortunately, higher speed is always coupled with less transparency and, as could be expected, this has led to several allegations of insider trading in the THA itself.

G. and H.-W. Sinn (1991) suggest combining a giveaway to investors with a giveaway to the population at large. 1/ The investor should be granted free of charge the equivalent in shares of his investment and job-guarantee plans for the firm to be privatized. All other shares of the firm should remain with the THA. These THA participations should be the basis of a distributive policy where vouchers are given to the East German population. At least after some time these vouchers could be exchanged for shares of the privatized firms. 2/ In the distribution of vouchers, priority should be given to those savers who suffered from the 2:1 conversion of part of their savings and to those employees who recommend to their trade union the acceptance of a four-year general wage moratorium (where East German minimum wages would not increase more than their West German counterparts).

The Sinn-Sinn “participation model” combines five basic elements: (a) giving away instead of selling; (b) granting a participation to the THA; (c) reducing East German wage increases by employees’ vouchers; (d) giving general vouchers to East Germans; and (e) helping East German savers. It is important to recognize that there is no need to combine precisely these five basic elements. 1/ If the reader follows my argumentation in the preceding section, he would agree that the privatization policy of the THA should not include, for instance, general vouchers and a priori entitlements of savers. 2/ Let us, moreover, forget the wage policy which should be linked to the employees’ voucher part of the model. First, this policy rests on the unrealistic assumption that trade unions agree to minimum wage increases that fall below those already negotiated for future years, at least in principle. 3/ Second, the wage policy, which is part of the Sinn-Sinn model, requires a complicated fine-tuning to achieve a movement of East German wages and employment along a particular path connecting the labor market equilibria before and after the transition of the East German economy. After excluding all these distributive features from the Sinn-Sinn proposal, let us look at the remaining ideas, that is, on the giveaways to investors and the participation of the THA.

As previously mentioned, a giveaway policy does not require purchasing power by the recipients. This advantage still applies if a giveaway policy is combined with THA participation. Such a policy attracts additional investors and relieves the strain on the capital market because investors need not borrow funds to pay for the purchase of the firm, but only for the purpose of new investments. This allows for some acceleration in the privatization process. However, one major advantage of a giveaway policy is lost if this policy is combined with THA participation in the firm: to determine the extent of THA participation, the value of the privatized firm must be computed to calculate the equivalent in shares of an investment and job-guarantee plan: Is a business plan of a potential buyer worth 22.17 percent of the shares of the firm or is it 24.23 percent? This determination of the precise extent of THA participation is quite difficult and would reduce the speed of privatization.

Moreover, there has always been some hesitation with respect to any form of partial privatization, since it may imply mixed and therefore unclear responsibilities and ongoing government interference. 1/ Let us concentrate on the problem of ongoing government interference. In several of my own publications, I suggested partial privatization to guarantee just such government influence. 2/ However, my suggestions referred to the privatization of public utilities in Western economies, where the Government would want to regulate the privatized firm and therefore a continued government influence is certain to happen. Here, a minority participation provides the German Government with additional information that will be useful for regulation. 3/ This argument fails to hold in the case of privatization of industrial firms by the THA. 4/ Government interference in those cases refers to THA activities to ensure that the firm stands by its investment and job-guarantee plans, and it may well imply further lobbying for jobs in the firm. This may deter potential investors. Hence, in the case of privatization of industrial firms, such ongoing THA interference is undesirable. 5/

Therefore, only a modified version of the Sinn-Sinn participation model can be recommended. The modifications refer to the two points of criticism mentioned in the preceding paragraphs.

First, the evaluation problem has to be overcome. I suggest that two and only two categories of THA participation be introduced--a 25 percent participation and a 49 percent participation. It should not be too difficult to assign a particular business plan of an investor to one of these two categories.

Second, continued government (THA) interference must be excluded. I suggest that the THA commit itself to a silent partnership, that is, that the THA retain only nonvoting shares. The THA must also make clear that the private owner will be at risk, that is, that the owner will not be bailed out in case of bankruptcy. (Such a commitment certainly is credible in the case of a 25 percent silent participation. I believe it should also work in the case of 49 percent.) 1/

Given these two decisive modifications, the Sinn-Sinn participation model can be seen as a recommendable policy. The silent participation could be used as a source of government revenue if the THA shares are sold at some later point in time. Alternatively, if somebody believes in the arguments in favor of a general voucher system, the participation model could be nicely combined with such a voucher system. The advantage of such a silent participation over the present THA policy is evident: the giveaway is restricted to 75 percent or 51 percent, respectively, of the firm, whereas the present THA policy increasingly runs the risk of giving away 100 percent.

3. Wage subsidies

To promote the rapid privatization of as many East German industrial firms as possible, the payment of wage subsidies has become highly debated, in particular because of the prestige of the Berkeley group which advocated this idea. 2/ According to Akerlof and his co-authors, the collapse of the East German economy is due to a shift of demand away from East German products and to a price-cost squeeze. Akerlof’s proposal concentrates on the latter. The rapid increase in East German wages (with the goal of matching West German wages in a few years) has increased costs to an extent that makes most firms “nonviable”: at world market prices they could not cover their short-run average variable costs. However, a firm which is not viable cannot be sold by the THA. Akerlof and his co-authors calculate that only 8 percent of the East German industrial labor force is employed in viable firms as a result of the present price-cost squeeze. 3/ Hence, they suggest reducing the short-run variable costs by paying wage subsidies to the firms. Subsidies of 50 (75) percent of total labor costs would imply that 37 (77) percent of the industrial labor force would work in viable firms. 4/ Unfortunately, these figures show wage subsidies in too favorable a light; they are static, that is, first year figures. If wage subsidies were to go on forever, and nothing else changed, these figures would be correct all along. However, the figures should be lower, that is, fewer firms would be viable if ceteris paribus the subsidies were to decrease over time, which seems to be the only acceptable policy. 1/

The net costs of wage subsidies are lower than the gross costs for the following reasons. If an otherwise unemployed worker remains employed, the Government saves on unemployment benefits and receives taxes and social insurance contributions. For the first year of unemployment, some 79 percent of the employee’s gross compensation is saved by a job-preserving wage subsidy. 2/ Hence, the authors suggest subsidies up to 75 percent of total labor costs. Moreover, in a perfect bidding for THA-owned firms, the respective wage subsidies are fully capitalized when selling the firm and, hence, pay for themselves. 3/ At least part of this capitalization might also hold in practice.

Firms which have been made viable by wage subsidies, can and should be promptly sold by the THA to the highest bidding private investor. There is no need to sell firms to purchasers who propose the most appealing investment and job-preservation plans. Jobs are preserved through wage subsidies which correct for the distorted price of labor, keeping both unemployment and migration from East to West Germany at a low level. 4/

However, it is precisely the job-preserving nature of the Akerlof plan which constitutes one of its weaknesses. Although wage subsidies are offered to all private industrial employment, therefore supporting both old and new jobs, the Akerlof proposal “risks fossilizing the status quo in production and employment.” 5/ After all, it is the declared intention of the Akerlof proposal to make artificially viable two thirds of the former GDR industry. 6/ However, the market forces must be allowed to eliminate those firms which stand to be abolished (even at the cost of higher unemployment and migration) because of the permanent shift of demand away from tradable East German goods. This permanent shift in demand requires restructuring of the economy and the establishment of new firms. 1/ Wage subsidies that are directed toward saving jobs in old firms are not the adequate instrument to apply to the transition from a planned to a market economy.

There are further serious objections against wage subsidies. The trade unions would push for higher wage increases than in the absence of wage subsidies 2/ and would also oppose the granting of such subsidies to profitable Western firms that invest in East Germany. 3/ Some investments would be shifted to East Germany only to obtain wage subsidies. 4/ Finally, the Akerlof plan would in all likelihood turn out to be more expensive than previously thought by its authors. 5/

Fortunately, the German labor market policy does not intend to apply a general wage-subsidy scheme à la Akerlof. However, wage subsidies are granted indirectly to all firms which are still in THA ownership because any deficits of these firms are paid by the THA. 6/ If THA privatization and liquidation policies are slow, these wage subsidies could go on for quite some time. Moreover, to reduce the official figures of unemployment, wages--at a reduced rate--are paid to employees who work short time, which sometimes is a euphemistic circumscription of working zero time. In East Germany, this short-time work schedule until the end of 1991 can even be applied if it is likely that the jobs cannot be preserved in the long run. This is particularly important for nonviable THA firms. The payment of short-time benefits is not contingent on training of the employees although the employers are supposed to make it possible for the workers to undergo vocational training and although higher short-time benefits are paid to workers during retraining.

When the special short-time provisions for East Germany are discontinued, some other measures of the German Employment Promotion Law (Arbeitsmarktförderungsgesetz) will become more important; 1/

(a) The Government pays a maintenance allowance during times of occupational retraining (and East Germans qualify more easily than West Germans for such courses). The Government also pays the costs of the training course;

(b) There are two schemes of wage subsidies: one to allow the occupational integration of the unemployed (40-50 percent 2/ of local wage paid up to six months, in exceptional cases up to two years), and another to promote additional jobs (grants of 50-100 percent of the wages for a maximum of one year; in exceptional cases, up to three years).

The wage subsidies of the Employment Promotion Law are short-run, marginal subsidies, that is, they do not refer to all employees. Hence, in contrast to the Akerlof proposal of general, not necessarily short-run, wage subsidies, they are much better shaped for the recovering East German economy. The transition from short-time labor pay to the wage subsidies of the Employment Promotion Law is a transition from a policy that subsidizes workers “who would be fired in the absence of the subsidy” to one that subsidizes those “who would not be hired in the absence thereof.” 3/ This is a consistent policy change: the first policy aims at mitigating the collapse of the economy, the second at promoting the recovery. If early 1992 is the time of the beginning of the recovery of the East German economy, then the swing from one type of policy to the other has been timed correctly.

It should be stressed that the policy of retraining, promoting human capital, should be intensified in order to increase labor productivity to catch up with increasing wages. Labor productivity will, of course, also increase because more capital of most recent vintages will be invested in East Germany. The scale effect of capital incentives (investment premia, tax credits, accelerated depreciation) makes them an alternative to wage subsidies, implying a tendency toward increased employment. However, capital subsidies increase the relative price of labor, which in the present situation of very high East German wages leads to an even more extensive substitution of labor by capital, implying overly capital-intensive industries 4/ and a tendency toward reduced employment. This is an imminent danger in East Germany, since quite generous capital subsidies have been provided for investment purposes in East Germany (similar to the policy which Italy applied to the Mezzogiorno). It is the hope of the Government and trade unions that eventually the scale effect of capital subsidies will outweigh the substitution effect, thus solving the employment problem in spite of the high wages. This hope is overly optimistic.

The further German economic policy will require a delicate balance between the retraining schemes and the wage subsidies on the one hand, and the capital subsidies on the other. Unfortunately, the trade union’s policy of high minimum wages makes this balance even more complicated. I fully share the opinion of a 1991 report of the Federal Government’s commission on deregulation, which recommends relaxing the strict German minimum wage regulations if too high minimum wages are coupled with long-term unemployment. 1/

IV. Restructuring

Restructuring is the second priority in the threefold catalogue of THA strategies. Restructuring means preparing an industrial firm for privatization, including, inter alia, the following activities:

  • The breakup of large conglomerates, the so-called Kombinate. The THA has been actively engaged in these activities;

  • The dismissal of former managers who are politically incriminated or lacking in managerial skills. The THA has been intensely active in this area and, by the end of June 1991, had replaced over half of its force of enterprise managers; approximately 20 percent of the new managers came from West Germany;

  • The reduction in the labor force; here the THA has acted cautiously; and

  • New investments to render the firms more attractive to private purchasers; here, the THA has not accomplished much to date.

The following discussion refers, in particular, to the latter two meanings of restructuring, that is, to active firm management by the THA, which entails a sort of direct government investment and job planning.

There is a theoretical point of view which argues that restructuring by the THA is futile, and that it should only proceed either to privatize or liquidate. If a firm is viable after restructuring, 1/ then there is some price at which the firm can be sold and the restructuring can be executed by the private purchaser. The background to this theory is the idea that private purchasers are generally more competent at restructuring than the THA, since they are directly interested in the value of the firm and well-informed on both the prospective chances of the firm and its internal organization. The THA, on the other hand, faces a principal-agent problem. Its knowledge typically comes from the firm to be restructured, where managers and employees have vested interests and will not inform the THA as forthrightly as required. According to this argument, the THA should be advised not to engage in restructuring. 2/

However, this theoretical argument is biased--it stresses all informational problems of the THA and places private investors in a first-best world of perfect information and incentives. There are some arguments in favor of a THA policy of restructuring, which will be presented as follows:

(a) The very definition of viability after restructuring by a private investor excludes taking account of externalities, productivity spillovers, etc. From a general economic point of view, the explicit consideration of these effects may be worthwhile and restructuring by the THA would be the adequate instrument;

(b) The THA can pool the risks of restructuring many firms, including environmental damage to be repaid, property claims by previous owners, and unexpected demand developments. The THA can also wait out until the necessary infrastructure has been set up and the administration has become more reliable;

(c) The THA may enjoy economies of scale and of scope in restructuring. Moreover, the more firms are restructured, the more experience is acquired;

(d) Western private investors are better informed on how to sell in Western markets and on the organizational aspects of a firm to be privatized. However, the THA might possess informational advantage with respect to the East German scenery 1/ concerning the treatment of East German employees, etc.; and

(e) The THA may have political advantages in restructuring. As a government agency, it has direct channels to other government agencies and could, for example, arrange a better coordination between the restructuring of firms and setting up of infrastructure. It could also exert political pressure to modify laws that inhibit the restructuring of firms.

These arguments look convincing from the point of view of second-best theory. One could easily think of theoretical models where the above advantages of the THA more than outweigh its being trapped in a principal-agent relationship with the firm to be privatized. However, in my opinion, the second-best economic theories simply miss the point, which is eminently political. I do not think that a large state-owned holding company is a good choice for restructuring. The second-best arguments restore the theories of planning which we want to eliminate. 2/ Moreover, a THA in full command of restructuring would not act according to a second-best model. It is to be feared that under political pressure, the THA would try to preserve firms which should otherwise be liquidated. “Restructuring” is often used as a label to disguise subsidization of nonviable firms. In particular, the THA would try to preserve jobs because such is the Government’s mandate.

For these political reasons, I think that restructuring should be removed from the responsibilities of the THA. Its activities should be reduced to privatization or liquidation. (If the THA is only able to sell around 4,000 firms per year, then some firms that are known to be viable will have to wait another year or two. “Restructuring” in such a framework would mean keeping these firms afloat until they are privatized.)

V. Liquidation 1/

If privatization proves impossible, then the THA will have to liquidate the firm. In spite of early closure of some prestigious firms, such as Interflug and Wartburg, the THA is very cautious and slow in closing down firms. Some of the reasons for such a policy are job preservation and the need to obtain additional information on the viability of East German firms.

However, by the end of, say, 1993, the picture will be much gloomier than at the end of 1991. Whereas in 1991 the easier privatizations will have taken place, the pace of privatization will necessarily slow and by the end of 1993 the THA will own only firms which private investors are unwilling to take over because they would be considered nonviable after restructuring. In particular, shipyards, and steel, coal, and chemical industries will constitute the core of the doomed remnants of the former GDR economy.

The THA is unlikely to liquidate all those firms by, say, January 1, 1994. On the contrary, it is to be feared that by subsidizing such firms for the next ten or so years, the mistakes will be repeated that were incurred by West German industrial policymakers with respect to the shipyards in Bremen or coal mining in the Saarland. 2/ Of course, the clear-cut recipe for the THA is to liquidate those firms which have not been sold by, say, the end of 1993. How can we make sure that such a policy is actually applied? Unemployment in East Germany will be high in December 1993, even without closure of all the remaining THA firms, and the Federal Government will be eager to capture votes for the end of 1994 election of the German Bundestag. Given this situation, the THA will be under pressure not to liquidate too many firms,

At that stage, the THA will have become a liability. What can be done to abolish the THA by then? Let us briefly consider some possible options to this problem.

(1) One could think of incentive wages for employees of the THA, which would depend on the number of both privatized and liquidated firms; no incentive would be given for restructuring. This scheme should be introduced right now, when the number of firms to be privatized is still high and the proposed incentive wage is a politically attractive way to reward THA employees for every case ultimately settled by the THA. (A sort of “anti-red tape” reward.) Over the course of time, it would become a scheme that primarily gives premia for liquidation. Then the scheme will serve two purposes: (a) it will accelerate the liquidation of nonviable firms, and (b) it will constitute a trade-off for THA employees--if they liquidate fast, they get premia at an early point in time, but also lose their basic income at an early point in time. In the absence of an incentive wage, only the latter would hold and employees might postpone liquidations to keep their jobs in the THA. In theory, the premia could well be formulated in such a way as to fully compensate the employees for the earlier loss of their basic income which resulted from the faster liquidation.

The incentive wage should depend on the number of liquidated firms, not on the number of employees or on the monetary value of the firms. The number of employees should not be a factor since it would give the THA an incentive to keep as many employees as possible just prior to privatization or liquidation. The value of the firm cannot serve as a basis for an incentive payment because, in case of liquidation, it is either nil or negative, or impossible to determine. The number of firms is a neutral indicator, if, say, the figures of mid-1991 are taken with possible allowances for large conglomerates to count as more than one firm. The strategic breakup of firms would then be avoided. There could still be some moral hazards because the incentive scheme would promote the privatization and liquidation of smaller, easy-to-handle firms, delaying the privatization and liquidation of larger firms whose case is more complicated to settle. If this becomes a problem, then the incentive wages should be related to weighted numbers of firms, the weights depending on the size of the firms.

(2) Another option would be to lower the THA borrowing limit. Limits which continually decrease over time should be published and the best course of action would be to publish them now, not in 1994. The decreasing limits should be set in such a fashion as to equal zero by the year 2000, thus signaling the Government’s determination to end THA activities by that time (a “sunset provision”). It could be questioned whether the Government can credibly commit itself to such a policy of decreasing the financial means of the THA, in particular since the credibility of the present Government has severely suffered from broken promises such as the introduction of an income-tax surcharge in spite of earlier promises that the German unification would take place without tax increases. The financial means to be distributed by the “fund on German unity” were defined in a decreasing way for 1991 to 1994. Meanwhile, however, these financial means have been increased, so as to achieve a nondecreasing pay schedule. 1/ Would not the same happen to an announcement of decreasing financial means of the THA? Unfortunately, this possibility cannot be excluded. However, even then the original law on decreasing THA finances would have signaled the Government’s intention not to let the THA go on forever, and would have presented a political barrier against easy increases in THA finances. 1/

(3) Needless to say, liquidations would be more readily accepted by the East German population if the laid-off employees were to be quickly re-employed. If new firms were set up near the firms to be closed, then there would be less opposition to such closures (even if high wages and low productivity would prevent the re-employment of all employees of a liquidated enterprise). However, it should be made clear that the THA cannot and should not be requested to restructure the entire economy. It is far beyond its “restructuring” strategy to take the primary responsibility for the establishment of new firms.

Much remains to be done by the federal and state governments to provide opportunities for the private establishment of new firms 2/, for instance:

  • Improvement of infrastructure;

  • Improvement of the public administration;

  • Rapid processing of property right claims;

  • Increase of bank flexibility for granting loans to potential new entrepreneurs;

  • Training of East German managers to promote entrepreneurial spirit;

  • Retraining of East German employees to stimulate occupational changes;

  • Relaxing of minimum wage provisions; and

  • Diluting of labor market rigidities. 3/

VI. Conclusion

The present policy of the THA consists of privatization by low-price sales or giveaways of industrial firms to those investors who present the best investment pledges and job guarantees. This policy has been successful in 1990-91: privatization of 2,500 industrial firms in the first six months of 1991 attests to much more than was achieved in Czechoslovakia or Poland during the same period. However, this paper argues that the extent of giving away national property could be reduced by applying a modified version of the Sinn-Sinn participation model, making the THA a silent partner of the private investors. The Akerlof proposal of a general scheme of wage subsidies has been rejected in the paper because it would lead to undesirable consequences and because the existing German system of retraining and wage-subsidy schedules seems to be preferable.

Furthermore, this paper argues that the 1991 euphoria of rapid privatization will have disappeared by the end of 1993, by which time the THA might have fully degenerated into a government-financed subsidization trust to keep alive nonviable firms in East Germany. Hence, I argue against restructuring by the THA and propose setting decreasing limits on THA finances for the years following 1994, and publishing these limits now and not in 1994, just before the next federal election. The decreasing financial inflow will force the THA to close firms, and will also signal the commitment of the Government to liquidate the THA itself by, say, the year 2000.

APPENDIX Data on the Treuhandanstalt (THA)

Property in 1990 1/

  • Approximately 9,000 industrial enterprises, with more than 45,000 business premises;

  • Approximately 20,000 commercial businesses;

  • Approximately 7,500 hotels and restaurants, plus some 1,000 pharmacies, bookshops, and cinemas; and Approximately 2.3 million hectares of farmland, and 1.9 million hectares of forests.

(This meant responsibility for approximately 3 million jobs.)

Privatizations prior to June 30, 1991 2/

  • Number of industrial firms sold: 1990 (July-December)-408; 1991 January-255, February-298, March-300, April-335, May-544, June-443, July-403.

  • (This totals 2,983 firms, which were sold for DM 11.6 billion.)

  • Number of small businesses sold by the end of May 1991: approximately 17,000 shops, cinemas, restaurants, and hotels. 2/

Number of liquidated firms 2/

  • Number of enterprises under liquidation until the end of May 1991: 450 (of which 350 underwent so-called “silent” liquidation).

Budget in 1991 (in billions of DM) 3/

article image

The deficit is financed by borrowing on capital and money markets. The borrowing limits for 1990 and 1991 together amount to DM 25 billion, according to the treaty on German unity. For 1992, borrowing of DM 32 billion is expected. Since the THA is a government agency, the Federal Government in any case is obliged to pay the deficit of the THA. After a closure of the THA, interest on and repayment of the THA debt will become an obligation of the Federal Government.

References

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*

This paper was written during Professor Bös’s stay at the IMF, Washington, D.C. All views and opinions expressed here are strictly personal. The author gratefully acknowledges helpful comments of many members of the Fiscal Affairs Department at the IMF, in particular, R. Hemming, G.F. Kopits, D.C.L. Nellor, G.J. Schwartz, A.A. Tait, and V. Tanzi.

1/

Calculated on the basis of Sachverständigenrat (1990), pp. 51-52, converting the currencies 1:1.

1/

According to Akerlof et al. (1991), unemployment is more important than wage differentials for the East-West German migration.

2/

The employers’ side was presented by former East German officials and managers who themselves were interested in high-wage increases (which also guarantee higher unemployment benefits). Moreover, the West German employers’ representatives did not interfere, most probably because they are not interested in low-wage competitors located within Germany.

1/

Throughout this paper, I exclude the special problems of the administration and privatization of the agricultural land and forests owned by the THA.

1/

For a good overview, see Borensztein and Kumar (1991).

2/

Sales of vouchers began in Czechoslovakia on October 1, 1991.

4/

The value of the firm is determined by issuing vouchers that are exchangeable for enterprise equity, where bidding by the population establishes an evaluation of the equity relative to the vouchers. The implementation of this convenient theoretical idea would, however, face serious problems, as mentioned in Borensztein and Kumar (1991), p. 309. Not only would the general population lack the expertise to bid for equity in exchange of vouchers, but the bidding would require a most complicated tatonnement process.

1/

In some of the proposals these alternatives are combined. See, for instance, Lipton and Sachs (1990).

2/

One hundred percent ownership given to intermediaries was proposed in Frydman and Rapaczynski (1991) and in Blanchard et al. (1991). The Polish mass privatization program suggested 60 percent ownership of the intermediaries--see Poland, Ministry of Ownership Changes (1991). A more sophisticated proposal for Poland was presented in Lipton and Sachs (1990).

3/

As any giveaway policy, voucher schemes help start privatization in economies lacking purchasing power and avoid the problems of determining the firms’ value. For further details on these arguments, see subsection 2. below.

1/

The communist concept of people’s property differs decisively from the Western concept of individual property. In the communist concept no individual rights result from people’s property; in the Western concept an owner has all conceivable individual rights with respect to the goods he owns, except some rights he is deprived of by governmental regulation and those rights that he has voluntarily renounced.

2/

See Article 41 (1) and the joint declaration of FRG and GDR of June 15, 1990, which is part of the treaty on German unity. However, former owners may be given monetary compensation instead of restitution in kind, if this is in the interest of prompt economic recovery. See Article 41 (2) of the treaty on German unity, and “Vermögensgesetz” in the version of April 1991. For political reasons, there is no restitution in kind for the nationalization in the Soviet-occupied zone of Germany (1945-1949). However, as the constitutional court in Karlsruhe ruled in 1991, in these cases the former owners may claim monetary compensation.

3/

Article 10 (6) of the treaty on the German economic, monetary, and social union (GEMSU), and Article 25 (6) of the treaty on German unity do not contradict the hypothesis raised in the text. According to these articles, remaining THA financial revenue should be passed on to savers who suffered financial loss when part of their savings were converted at 2:1. This accepts an implicit claim by savers to convert all their savings at 1:1; and does not accept a claim of the general population with respect to their former people’s property. Moreover, it definitely refers to the remaining THA financial revenue “after use of the people’s property for structural adjustment of the economy and for reduction of the government budget deficit (Sanierung des Staatshaushaltes).” Hence it postulates an expost policy, not a policy of compensations paid to savers, say, in 1991, before it is clear whether there will be any THA financial revenue. The latter postulate has been raised by G. and H.-W. Sinn (1991), pp. 110-121. For the opposing view, see Beirat of the Bundeswirtschaftsministerium (1991), pp. 16-18.

1/

Both quotations from Estrin (1991), p. 171.

2/

See the detailed discussion in H.W. Sinn (1990) and G. and H.W. Sinn (1991), pp. 83-109. Also see, however, Beirat of the Bundeswirtschafts-ministerium (1991), p. 17.

1/

This proposal is aimed at shareholding companies. For other privatization cases, Sinn and Sinn suggest selling firms or other property at positive prices, but crediting the investor with the payment.

2/

In G. and H.-W. Sinn (1991), p, 114, some alternative scenarios of distributive policies are mentioned.

1/

In October 1991, the German union of metal workers’ (IG Metall) proposal suggested inter alia a “TH property fund” which should hold a 25 percent participation--first, in the THA, and, after privatization, in the privatized firms. Fifty percent of the shares of this TH property fund should be distributed to the general public free of charge. (For the remaining 50 percent of the shares, forced sales to higher-income earners were proposed by IG metall--certainly an element not contained in the Sinn-Sinn package.) See Institut der deutschen Wirtschaft, Informationsdienst des Instituts der deutschen Wirtschaft, No. 44 (1991).

2/

See footnote 2, p. 8.

3/

G. and H.-W. Sinn even suggest having this moratorium made retroactive to April 1, 1991 (their book appeared in October 1991).

1/

Of course, this argument does not hold if the THA is privatized, as briefly mentioned in G. and H.-W. Sinn (1991), p. 114. However, in my opinion, we can safely discard this possibility.

2/

These are assembled in Bös (1991a), pp. 135-148 and pp. 219-284.

3/

Moreover, the remaining shares may be sold at some later time without too much underpricing.

4/

This can theoretically be shown for a welfare-maximizing privatization policy. See Bös and Peters (1988) and Bös (1991a), pp. 247-249. Unfortunately, in Bös (1991b), I took a deviating position.

5/

Sales with credited payment, as suggested by G. and H.-W. Sinn (1991) for THA property other than shareholding companies, avoid THA minority participation. However, when the payments are finally due, they would go to the THA, which at that point in time would use the funds to subsidize nonviable firms. This problem would then be met insofar as the funds would not be directed to the THA, but to the population--for example, to savers, as suggested by G. and H.-W. Sinn.

1/

At one time I thought a 75 percent silent participation of the THA might be worth considering. However, I do not believe that in such a case the THA could credibly commit itself to not bail out the firm if it goes bankrupt.

2/

See Akerlof et al. (1991). See also Begg and Portes (1991).

3/

The authors obtained a set of cost data, previously used for GDR planning, which they adjust to the present situation by: (a) removing all profits, interest, and depreciation in excess of repairs necessary for current operation; and (b) taking into account changes in the tax structure, in the cost of imported intermediate inputs, and in wages. The resulting modified short-run average variable costs are then compared with the respective world market prices.

4/

See Akerlof et al. (1991), p. 28.

1/

How many firms are viable in case of decreasing wage subsidies depends on the time schedule of subsidy reductions, on the discount rate applied by the investors, and on their expectations of the East German economic development.

2/

Akerlof et al. (1991), p. 71. Gross compensation is gross wage plus employer’s contribution to social insurance.

3/

Akerlof et al. (1991), p. 72.

4/

Surveys conducted by Akerlof et al. showed that unemployment is the main reason for migration to the West. See Akerlof et al. (1991), pp. 45-55.

6/

See Akerlof et al. (1991), p. 27: firms which employ 77 percent of the industrial work force are viable if wage subsidies of 75 percent are granted, which is the alternative favored by the authors. In the absence of wage subsidies, only 8 percent work in viable firms.

1/

If it were a temporary shift only, wage subsidies would perhaps be an adequate instrument (see Guitian (1991), p. 93).

2/

Akerlof et al. (1991) suggest a “self-eliminating flexible employment bonus program” where wage subsidies are inversely linked to wage increases. The authors claim that “in simple maximizing models of union behavior, the … plan usually makes wages sticky when unemployment exists” (p. 81). It may be doubted that such a program would work in practice (see Guitian (1991), p. 97-98).

3/

This argument was actually decisive for the retraction of a German trade unions’ plan for East German wage subsidies. See Akerlof et al. (1991), p. 72.

4/

This might even require some subsidization of West German, e.g., West Berlin firms--see Akerlof et al. (1991), p. 84-85.

5/

See Guitian (1991), pp. 97-98.

6/

There exist proposals that the Government should set up enterprises which are considered “employment companies.” These proposals are to be rejected in any case. If there is any need for new firms, private entrepreneurs should enter the market.

1/

A brief overview of these measures is given in Federal Ministry of Economics (1991), pp. 94-100.

2/

In special cases, 50-70 percent.

3/

See Kopits (1978), p. 497.

4/

See G. and H.-W. Sinn” (1991), pp. 165-170.

1/

If such relaxations became possible, it should be made clear that the THA also applies them. Otherwise, privatized firms offering lower wages would not be competitive with THA firms which can pay higher wages because their deficit is always covered. See G. and H.-W. Sinn (1991), p. 189.

1/

This definition of viability differs from Akerlof’s. Viability after restructuring is given if the present value of revenues from sales minus the present value of costs, including costs of restructuring, is positive. In this definition, revenues and costs are as calculated by the private investor, not by the THA.

2/

This is the predominant opinion in Germany. See Sachverständigenrat (1991) and Beirat of the Bundeswirtschaftsministerium (1991). See also G. and H.-W. Sinn (1991), pp. 85-86.

2/

Not surprisingly, the October 1991 reform proposal of the union of the metal workers (IG Metall) speaks of “volkswirtschaftliche Sanierungsfähigkeit” (restructuring which is justified from a general economic point of view, i.e., not necessarily profitable for a private investor).

1/

In the United States the huge government bailout of the savings and loan industry led to a problem similar to the THA liquidation case. The Federal Deposit Insurance Corporation and its affiliate agency, the Resolution Trust Corporation, are in charge of liquidating many government-owned banks and savings and loan institutions. The Resolution Trust Corporation has explicitly been scheduled to go out of existence in 1996. Unfortunately, such a clear end date has not been set for the THA liquidation activities.

2/

See Streit (1991), pp. 175-176. The same mistakes were also made in other countries; the IRI in Italy is a good example.

1/

At an informal meeting some months ago, I proposed that the THA should set a date, say, January 1, 1994, at which time it will give away the remaining nonprivatized firms to the firms’ managers (including partial employee participation). However, I have changed my mind. Now I definitely believe that moral hazards make this a bad proposal.

3/

See Bös (1991b), p. 16.

2/

THA (1991).