Prepared by Albert Jaeger.
This absorption gap was present across all main spending components of aggregate demand (Chart III-2, Table III-1). For comparison, rough estimates for Italy’s southern region (the Mezzogiorno) indicated an absorption gap of some 19 percent of regional GDP in 1988. See Andrea Boltho, Wendy Carlin, and Pasquale Scaramozzino, “Will East Germany Become a New Mezzogiorno?”, CEPR Working Paper No. 1256 (London: Centre for Economic Policy Research, 1996).
The difficulties in implementing the convergence strategy, especially the likely harmful consequences of substantially misaligned wages for the medium-term convergence process in the new Länder were noted in the collection of studies edited by Leslie Lipschitz and Donogh McDonald, German Unification: Economic Issues, Occasional Paper No. 75 (Washington: International Monetary Fund, December 1990).
See Deutsche Bundesbank, “The Trend in Agreed Pay Rates and Actual Earnings Since the Mid-Eighties,” Monthly Report August 1994, Vol. 46, No. 8, pp. 29-44.
Ministry of Labor and Social Affairs, Tarifvertragliche Arbeitsbedingungen im Jahre 1996 (Bonn: Ministry of Labor and Social Affairs, February 1997).
Several reasons account for the incomplete convergence: the tariff agreements do not cover non-wage remuneration and other benefits, including leave pay and bonuses that have remained significantly below west German levels; effective wage payments in the old Länder include past positive wage drift, while wage drift in the east has been negative (averaging 1½ percent per annum during 1993-96); the payment of below-tariff wages, while exceptional in western Germany, appears to be a widespread practice in the east; and firms facing financial difficulties have applied for exceptions to labor agreements (including those related to wages and work conditions) or in extremis, some firms have ignored their agreements often with the tacit consent of the unions.
See, e.g., Kornelius Kraft (1994), “Wage Differentials Between Skilled and Unskilled Workers,” Weltwirtchaftliches Archiv, Vol 130, pp. 329-47.
The measures of unit labor cost reported in Tables III-3 and III-6 are defined as labor cost per employee divided by nominal value added per employed person. This “nominal unit labor cost” measure—as opposed to the conventional “real unit labor cost” measure which are based on real labor productivity—has been employed to avoid overstating the loss of labor competitiveness following the equalization of prices in the east with those in the west. In particular, it has been argued that the distorted price structure in the east before unification (on which real labor productive would be based) included many below-market prices that were subsequently adjusted to market levels without loss of competitiveness. However, this is unlikely to apply to all goods. Thus, the real measure is likely to overstate the true magnitude of the unit labor cost gap, while the nominal measure is likely to understate it.
It has been pointed out that low labor productivity levels in some sectors in the new Länder may also reflect low capacity utilization levels due to the lack of successful marketing of products. In support of this hypothesis, it has been noted that industries with a large share of companies owned by west German firms and therefore with better market access—such as the chemicals industry—have performed significantly better than other industries. See Hilmar Schneider, “Die ostdeutsche (Maschinenbau-)Industrie im Transformations- und Globalisierungsprozess,” in: Rüdiger Pohl and Hilmar Schneider (eds.), Wandeln oder Weichen: Herausforderungung der wirtschaftlichen Integration für Deutschland (unpublished, 1997).
The ratio for effective average pension benefits in eastern Germany is even higher, reflecting the longer average pension contribution records of wage earners in the east.
Including both unemployment insurance benefits (Arbeitslosengeld) and unemployment assistance (Arbeitslosenhilfe).
Official data on absorption in the new Länder are only available through 1994, and the data for 1995-96 represent staff estimates.
However, net financial assets of private households in eastern Germany lagged far behind west German levels—reaching only about 30 percent of the west German level in 1994. See Deutsche Bundesbank, “Overall Financial Flows in Germany in 1994,” Monthly Report May 1995, Vol 47, No. 5, pp. 17-42.
The official estimates of the east German capital stock are sensitive to the initial value of capital in 1991 and include the value of residential buildings. Capital stock estimates based on a production function approach indicated that the initial east German capital stock was probably some 30 percent below the official estimates used in this chapter. See Christian Thimann, Aufbau von Kapitalstock und Vermögen in Ostdeutschland: Der lange Weg zur Einheitlichkeit der Lebensverhältnisse (Tübingen: J.C.B. Mohr, 1996). Investments in residential buildings do not add directly to the productive capacity. About 22 percent of gross fixed investment in eastern Germany during 1991-94 was investment in residential buildings (compared to a share of 30 percent in western Germany).
For example, a convergence speed (β) of 0.10 means that in each period 10 percent of the gap in the capital-labor ratios in the previous period is closed.
See Robert J. Barro and Xavier Sala-I-Martin, Economic Growth (New York: Mc Graw Hill, 1995) for evidence on convergence speeds for low-income regions in the United States, Europe, and Japan. The reported convergence speed estimates are generally around 0.02-0.03 per year.
This scenario was based on actual employment during the period 1991-96. To achieve higher employment in eastern Germany, and thereby reduce unemployment, the investment requirements would have to increase substantially.
On average during 1992-96, the inflow into unemployment expressed as a percent of employment amounted to 2¼ percent per month, while outflows from unemployment expressed as a percent of unemployment averaged to 12½ percent per month.
An earlier analysis of unemployment flow dynamics in eastern Germany, reported that substantial “circular flows” between job creation programs and registered unemployment could have occurred during 1991-92. See Michael C. Burda, “Modeling Exits from Unemployment in Eastern Germany: A Matching Function Approach,” CEPR Working Paper No. 800 (London: Centre for Economic Policy Research, 1993). This paper also provides evidence on unemployment flow dynamics in other eastern European economies.
To soften potential labor market dislocation, the privatization of firms by the Treuhandanstalt was often tied to temporary employment guarantees (usually in the range of 2-5 years) by the new owner. About 80 percent of these employment guarantees expired by 1996 or earlier. Some 10 percent of the guarantees is scheduled to expire in 1998 or later (information provided by the Economic Research Institute Halle).
See, e.g., Christian Thimann, “Effective Taxation for Recipients of Social Assistance in Germany and the Consequences of the 1996 Tax Reform,” IMF Working Paper 95/120 (Washington: International Monetary Fund, 1995).
The differences in estimates of the implicit tax rate in 1996 are due to differences in the earnings ceiling exempt from social security contributions (DM 580 in western Germany and DM 500 in eastern Germany) and the somewhat higher social assistance payments in western Germany.
Before 1995, a large share of intergovernmental transfers to eastern Germany were received from the German Unity Fund, which ceased operation at end-1994.
See the Fifteenth Report on Economic Developments in East Germany by the German Institute for Economic Research Berlin, the Institute for World Economics Kiel, and the Institute for Economic Research Halle (1997).
A strategy of temporary wage subsidies has often been proposed as a promising approach to mitigate the labor market distortions in eastern Germany. See, e.g., the analyses in Akerlof and others, “East Germany in from the Cold: The Economic Aftermath of Currency Union,” Brookings Papers on Economic Activity, 1991, pp. 1-87. The wage subsidy proposal has, however, not found much public support in view of fears that it could impose severe additional distortions on factor allocation and prove ineffectual if unions were to press for still higher wages.
See “Mittelfristiges Förderkonzept der Bundesregierung für die wirtschaftliche Entwicklung in den neuen Ländern nach 1988,” Aktuelle Beiträge zur Wirtschafts- und Finanzpolitik (Bonn: Presse- und Informationsdienst der Bundesregierung, May 1997).
These simulations are based on the long-term employment projections underlying the staff’s pension expenditure projections reported in Chapter V and assume an identical depreciation rate (4 percent) for the capital stock in east and western Germany.
The World Economic Outlook (May 1997, pp. 62-63) provides a brief description of Ireland’s catch up growth experience.