XII
The Role of Fiscal and Structural Policies in German Unification Lessons from the Past
Thomas Mayer
The process of Gennan economic, monetary , and of economic policy was, therefore, to provide a secure social union (GEMSU) raises many questions about the and unobtrusive legal and financial framework within role for economic policy, both in influencing the overall which markets could operate efficiently. degree of resource use in the economy and in pursuing Ordnungspolitik, as this policy has been called, allo an efficientallocation of resources. This chapter analyzes cated clearly defined tasks to each aspect of economic these questions against the background of past experience policy, that is, monetary, fiscal, and structural policy. with economic policy in the Federal Republic of Germany The main task of monetary policy was to ensure stability (FRG). Three major periods of economic policymaking of prices and the currency. This required the establishment can be distinguished in the FRG: fTom 1948 until about of a strong and independent central bank that was legally the mid-1960s, a period of strongly market-oriented bound to pursue these objectives. Thus, the central bank's policies associated with Ludwig Erhard; from the mid- commitment to these objectives could not be overruled 1960s to perhaps the early 1980s, a period of Keynesian by the government. Fiscal policy was charged with the policies associated with Karl Schiller; and, since the role of providing a tax system that generated enough early 1980s, a revival of Erhardian ideas.' revenue (with as little distortion of market signals as possible) to finance expenditures for the classical tasks of government. There was no room in this concept for The Period of Liberalism: Financing the fiscal demand management policies and, in fact, the Essential Government Tasks general government accounts were in surplus during the 1950s and the first half of the 1960s (see Chart 11 in Economic policy in the FRG formally began in 1948 Chapter 11). Structural policies were seen as passive with the merger of the U .S., British, and French occu rather than active: the objective was to provide an pation zones into one united economic area and the economic structure that rewarded competitiveness and currency refonn. 2 The conceptual framework that gov facilitated structural adjustment in response to market erned economic policy, however, was developed much forces. Strong antitrust laws and laws that ensured fair earlier, in the writings of Ludwig Erhard and others, competition were essential to this objective. 4 before and during World War IL The writings of these this opportunity in order to refute the criticism sometimes directed economists reflected a reverence for market forces as the against it. Entrepreneurs will once more have to resolve the problem best guide to economic decision making. 3 The main task of producing for a market without any purchasing power i.e. devoid of sure sales." See Srandard Texrs of rhe Social Marker Economy: Two Cemuries of Discussion (Stuttgart: New York: Gustav Fischer. ' See Leslie Lipschitz and Thomas Mayer. "Accepted Economic 1982). p. 7.
Paradigms Guide German Policies." IMF Survey (Washington), • Waiter Eucken, in an essay written in 1952 C'A Policy for November 28. 1988. pp. 370-74. Establishing a System of Free Enterprise"), described this policy in 2 See. for example. Thomas Mayer and Glinther Thumann, "Radical the following words: "The fundamcnral principle not only calls for Currency Reform: Germany. 1948." Finance & Developmem (Wash abstinence from certain economic acts such as government subsidies. ington). March 1990. pp. 6-8. the establishment of mandatory State monopolies. a general freeze on ' In a paper written in 1943-44 ("The Economic Needs of Postwar prices. prohibitions of imports etc. Nor is it enough simply to prohibit Germany"). Erhard emphasized the role of the private sector in the cartels, for instance. The principle is not primarily negative in nature. reconstruction effort as fo llows: "the State's economic power and There is. rather, a need for a positive economic policy aimed at initiative arc bound by strictly circumscribed limits so that trade and developing the marketing structure of unrestricted competition and industry will be largely left to their own devices in finding ways of thus at realizing the fundamental principle. This is also a field in providing a new basis for Germany's economic life by establishing a which the competitive system differs entirely from the policy of new gross national product. The private sector of the economy will laissez-faire, which in substance did not admit of any positive system enjoy a fresh opportunity to dcmonstnne its skill and it must seize of economic regulation." Ibid. p. I 16.
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©International Monetary Fund. Not for Redistribution XII • FISCAL AND STRUCTURAL POLICIES IN UNIFICATION
This description of economic policy should not be policy issues and occasional modifications of the policy taken to suggest that the system was one of virtually framework when these were needed because of economic unbridled market forces. Indeed. economic policy was developments. The other economic policy institutions, constrained by social policy that ensured consensus the Ministry of Finance and the Deutsche Bundesbank, between the so-caJled social partners, organized labor had an essentially supportive role. To play this role was, and capital. In this sense, there was government inter however, not always easy. Monetary policy, for example, vention to influence market forces. But the intervention was often caught between domestic considerations and was not ad hoc or unpredictable; social policy consisted the external constraints imposed by the Bretton Woods of a set of rules-similar to the rest of the institutional system of fixed exchange rates, as the German target for and legal framework of the economic system-that set inflation often differed from those of trading partner the bounds within which market forces could operate. countries. In most cases, the record suggests that external In the thinking of the postwar German "Ordo-liberal" constraints prevailed over domestic objectives. 7 economists, the role of social policy was important, if The rejection of the notion that economic policy should not vital, to the success of economic policy. This view try to steer economic developments was reflected in the had historical roots. In postwar Germany, the memory relatively small size of government during the 1950s and of the close cooperation of big industry with the Nazi early 1960s. In 1955, the share of government revenue regime was still vivid. It was believed that the involve in GNP was 35 percent (more than I 0 percentage points ment of labor in industrial management, through workers· below the share in the mid-1980s, see Table A 15 in councils and economically strong trade unions, was Chapter Tl). The share of government expenditures in essential to the well-being of the young democracy and GNP was only 30 percent (almost 20 percentage points for economic prosperity. On economic grounds. social below that reached 30 years later), and the government policy was seen as helping to overcome the traditional accounts registered a considerable surplus. antagonism between capital and labor so as to foster a The noninterventionist paradigm of the 1950s and social environment conducive to a smoothly functioning early 1960s, supported by a favorable economic envi economy.5 The main instruments of social policy were ronment, was associated with a buoyant economy: real the establishment of comprehensive unemployment, health, per capita GNP growth averaged close to 7 percent and pension systems, as well as institutional regulations through the 1950s; unemployment declined from almost that allowed for the representation of labor in the main 2 million in 1950 to 300,000 in 1960; inflation was areas of industry. below 2 percent on average during 1950-60: share prices The combination of a market-oriented economic policy rose manyfold in the 1950s; and real interest rates on with an active social policy came to be known as Soziale government bonds averaged about 4\12 percent during
Marktwirtschaft (social market economy). 6 The execution 1955-60. of this policy was fairly straightforward. Once the economic framework was in place, the Ministry of Economics, headed by Erhard, took over the role of the guardian of its principles. Day-to-day management was The Period of Keynesianism: Restoring not required, and the Ministry concentrated on basic Internal Equilibrium
5 In 1944. in "The Guiding Principles of the Liberal Programme," In the early 1960s, the Social Democratic Party (SPO) Wilhelm Ropke wrote. ·'If left to itself. a market economy is dangerous moved from the left toward the political center. In the and indefensible because it reduces people to a thoroughly unnatural area of economic policy, the old, more socialist existence which they then cast aside together with the free market which has become hateful. In other words. the market economy philosophy was replaced by a moderate Keynesianism. re quires a (·iml framework, which we may conveniently refer to in When the SPD formed a government with the Christian short as the anthropological-sociological framework. If this framework Democrats (CDU) in J 966, the ground was laid breaks down. then it is no longer possible to have a free market. In other words. market economy is not everything. lt has a special place for the application of these ideas. At the same time, in a healthy and efficient society where it is indispensable and where there was also something of an international consensus it must remain pure and undiluted.·· Ibid. p. 190. on Keynesian policies. • In 1947, Alfred Miiller-Am1ack spelled out the theoretical foun dations of the social market economy in "The Social Aspect of the Economic System" as follows: .. We would therefore be well advised to look for a new system which will ham1onize both the social aims 1 In the mid-1960s, for example, a major battle took place within of our time and the most fundamental tenets of business practice and the so-called Grand Coalition between the CDUICSU and the SPD the science of political economy . Such a synthesis can only beachieved over the question of a revaluation of the deutsche mark. The SPD. by the re-establishment of a genuine market economy. This new led by Karl Schiller, the Minister of Economics, argued that a market economy must distinguish itself from the liberal market revaluation was needed to dampen inflationary pressures caused by economy of the 19th century which. like the system of central control. the sizable balance of payments surpluses. Chancel lor Kiesinger (CDU) is a thing of the past. by virtue of its social objectives. We must build rejected the request. The exchange rate emainedr unchanged until the a ·social Market Economy· . .. Ibid. p. 17. end of the 1960s when a new SPD/FDP government was elected.
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©International Monetary Fund. Not for Redistribution The Revival of Erhardian Ideas
The main proponent of Keynesian policies in Germany been rarely used since its introduction,10 the spirit of the at this time was Karl Schiller. in contrast to the "Ordo- law influenced fiscal policy during most of the 1970s. 1 ibcral'' school, he argued for active demand management Prime examples of Keynesian policies were the Govern policies by the Government with a view to maintaining ment's reactions to the first oil price shock in 1974 and full employment in the economy. Given the limited scope the program that it undertook at the time of the May for independent monetary action in the fixed exchange J 978 Bonn economic summit. A1 this summit meeting rate system of the time, the obvious instrument was fiscal of the heads of state or government of the Group of Five policy. The ·'mini-recession" of 1967 provided the first countries, Germany and Japan committed themselves to test case for the application of these policies. After strong more expansionary fiscal policies, while the United States growth in 1964-65. the economy had weakened in the promised greater fiscal restraint; the objective was for course of 1966 and had fallen into mild recession in policies in Germany and Japan to supp011 economic 1967. Schillcr interpreted this development in the fo l growth and, combined with those in the United States. lowing way: ''The absence of ...a coordination between to redress the trade imbalances that had emerged among fiscal and monetary policy as well as between actions of the major industrial countries. A stimulatory fiscal pack the government bodies on the one hand and the auton age, based chiefly on public construction. was introduced omous social forces on the other hand was responsible with the budget for 1979. However. this investment ...for the deepest recession in the Federal Republic in program, though countercyclical in intention. was not so the post war period in 1966-67. · '8 The Government in effect. Indeed, the increase in public construction in reacted with deficit spending and so contributed to a 1979-80 reinforced a boom in private construction and strong economic rebound in the fo llowing year. At the the subsequent drop in public construction coincided same time. a law was enacted that was intended to with a fall in private construction activity. provide a fr amework for the regular application of The 1967 "mini-recession" had been handled in a demand management policies (Gesetz zur Forderung der textbook manner, 1 1 but subsequent episodes of fine Stabiliriir und des Waclzstums der Wirzschaft or "stability tuning showed up a basic flaw: postrecession efforts at law".)'� demand management proved incapable of reining back The law stated that fiscal policy at all levels of fiscal deficits.12 Thus, fiscal deficits and public debt rose government (federal, state, and municipal) should be during the 1970s and early 1980s to levels unprecedented directed at maintaining price stability. a high level of in postwar Germany as policymakers struggled to deal employment. external balance. and appropriate economic with an unfavorable external environment (see Chart I J grow1h. These four objectives were to be taken into in Chapter 11). In this process. the structure of revenues account when budgets were drafted. But the law also and expenditures changed substantially (see below). provided ins1ruments-such as expenditure freezes. pub Moreover, as a result of the increase in the share of lic borrowing ceilings. and additional government ex expenditure on entitlements and debt service, the room penditures-to adjust fiscal policy between budgets. for discretionary spending diminished sharply. In the Private investment could be stimulated through invest event, these developments contributed to the fall of the ment premiums. or it could be dampened through limi SPD/FDP government. tations on depreciation allowances. A particularly pow erful instrument under the stability law was the so-called tax regulator. Under this provision. prepayments of The Revival of Erhardian Ideas income taxes could be changed and, if necessary. income and corporation taxes could be raised or reduced by up to I 0 percent. A 11 of these instruments could be i mple Attempts at ' 'Consolidation'' mented fairly quickly by the Federal Government pro vided both houses of parliament agreed . The second oil price shock in 1979 coincided with Lhe Although the tax regulator under the stability law has stimulatory effects of the internationally coordinated
10 The tax regulator was used in 1970 and 1971 to raise DM 2'/.1 • Karl Schillcr. "KnnjunklUrpolitik auf c.JcmWege zu ciner Affluent billion and DM 3% billion. respectively. in additional !axe> 11)withdraw Sodcty." Kiclcr Vortriigc No. 54 rKicl. 1968). p. 8 (translmec.J). stimulus from the economy. Of this. DM 5·Y.o billion wa5 repaid in 1972
• S(·hillcr gave the following charactcrizmion of the Stability Law: and DM V.. billion in 1973. shortly before the rise in oil prices triggered "The tool box of demand management possibilities provided by this a recession. law is indeed extraordinarily rich: in fact. it is probably the most " After deficits in 1967-68. the federal budge! ran surplu�c� in 1969-- modern ton! box available. But ... this law is not a panacea. I! 70 when economic activity was strong (sec Chart ll in Chapter 11). provide' . . . instruments to counter a recession or dampen an " Schiller. who became ··super.. Minister of Finance and Economics overhc;Hing of the economy. But it does not. for instance. provide in 1971. resigned in 1972 mainly because he was concerned about this instruments to boost un,ali!>factory economic growth." Sec ibid .. p. inability to control deficits in the aflermmh of cyclical downturns and 9 (tran�lated). recoveries.
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©International Monetary Fund. Not for Redistribution XII • FISCAL A D STRUCTURAL POLICIES IN UNIFICATION economic action of 1978 and led to a sharp worldwide The new economic strategy contained a number of increase in inflation. In the FRG, higher oil prices together implications for structural and fiscal policies. The task with the rapid. policy-induced, growth of domestic of structural policy was to attack the rigidities present in demand produced. in 1980. the largest external cun·enr the economy with a view to speeding up adjustment. In account deficit in postwar history. At the same time, an particular, Iabor market rigidities that had increased international consensus began to emerge that forces had significantly over the previous decade were to be eased: to be concentrated on fighting inflation and that the old subsidies to ailing industries were to be curtailed: many recipes of demand management would not help put the areas of industry were to be deregulated: and important world economy back on its feet. In a major change of state enterprises were to be privatized. The task of fiscal .. fiscal policy in 1981, Chancellor Schmidt gave priority policy was to "consolidate the government finances to the reduction of tlscal deficitsover demand stimulation and to pursue medium-term objectives-the Government of the economy, but he did not find the full support of was loath to set any targets on variables such as real his parry in this endeavor. Otto Lambsdorff. the FOP growth. unemployment. or external balances and disa Minister of Economics at this time, explained in a now vowed the stop-and-go policies of the past. There was a famous "U-turn" paper (Wendepapier) why he thought quantitative and a qualitative aspect to consolidation. it was impossible to pursue the appropriate economic The term "quantitative consolidation" meant the reduc policies within the tl1en government.u This triggered the tion of governmentexpenditure, revenue, and the budget ., end of the SPD/FDP Government and the move of the deficit relative to GNP; "qualitative consolidation meant FOP into a coalition with the CDU/CSU in October the refo1m of the tax system and a restructuring of 1982. The disenchantment with the interventionist par government expenditure away from cunent spending adigm, which had set in already in 1980-8 1. was then toward investment. Given the complexity of the program. endorsed by the 1983 elections. The new CDU/CSU/ the politicians thought that a gradual implementation was FDP coalition won a majority on an economic platform appropriate. In the first step. the most detrimental rig committed to a more limited role for government and a idities in the labor market would be eliminated and greater reliance on market forces. government spending and budget deficits would be The new Government saw the lax fiscal policies of curtailed. This was expected to create more room for the previous years as the main problem. The increase in maneuver for both fiscal and structural policies so that. the share of government revenue, expenditure. and of in the second step, the ·•qualitative·' consolidation of the deficit in GNP in the course of the 1970s (see Table government finances and the deregulation of the economy Al5 in Chapter 11) was believed to have deprived the could follow. private sector of the resources it needed to contribute to During its first legislative period. the Government was healthy economic growth and a reduction of unemploy indeed successful in improving the state finances. The ment. In addition. an overly generous social policy share of general government expenditures in GNP de with social transfers equivalent to 18 percent of GNP in clined from 49:Y4 percent in 1981-82 to 47 percent in 1986. 1982-was believed to have contributed to the high rate This made possible a narrowing of the general government of unemployment by pushing up wage costs and sup deficit from about 3112 percent of GNP in 198 1-82 to 1114 pressing incentives to work. Also. the micro-management percent of GNP in 1986 and a lowering of the share of of industry by the Government. through rules, regula general government revenues in GNP from 461/J percent to tions. direct subsidies. and incentives. was held respon 45'12 percent over the same period . There was a significant sible for structural rigidities in the economy and a general cutback in social expenditures by the government as well: inability to adjust to the new international environment: the share of these outlays in GNP fell from 17·% percent these rigidities. which were seen as a broader European in 1981-82 to 16 percent in 1986. despite a rise in the problem. were dubbed "Eurosclerosis. ''141n short. there unemployment rate . Also. Jabor market legislation in 1984- was a widely held view Jhat government interference in 86 limited the trade unions' negotiating power in labor the economy had proved counterproductive and that it was necessary to ··pare down the state to the core of its described the role of fiscal policy in more uct
(rnimcographcu: Bonn. 19!!2). in lhc dependability of po licies. Welt-ordered public budget\ 11ro: llllls an .. " Sec. for �xamplc. Hcrhcn Gicrsch. "Euro•clcro'i> . Kiel Discussion imponant ba:.is for long-term dcci>ion� ... and pan of the fou nd
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©International Monetary Fund. Not for Redistribution The Revival of Erhardian Ideas disputes, improved the conditions for the hiring of youths forward OM 5 billion of the tax cuts envisaged for 1990 and part-time workers, and increased the flexibilityof labor to 1988, raising the size of the tax cut already scheduled contracts. 16 from DM 8'12 billion to almost DM 14 billion (-% of I Relatively little progress. however. was made in the areas percent of GNP). This. it was thought. would help bolster of qualitative consolidation of government expenditures, domestic demand and contribute both to stronger growth privatization of state enterprises. and deregulation of the and a more rapid reduction of the current account surplus. economy. Contrary to the authorities' intentions, the share Against the backdrop of turbulence in fi nancial markets in of subsidy payments in total expenditures increased from the latter part of 1987, the Federal Government decided in 3� percent to 4'12 percent between 1981-82 and 1986; only December 1987 to take further fiscal action to support a small part or the privatization program was catTied out; economic growth. The measures included additional loans and the process of deregulation was slow. to municipalities and medium-sized enterprises and an On the other hand. soon after some progress in quantitative increase in invesnnent by the Federal Postal System. Later. consolidation became visible, the objective of reducing and in January 1988, when confronted with an unexpected reforming taxes gained momentum. In 1985, a DM 20 shortfall in revenues due to lower-than-expected profit billion (I percent of GNP) tax refom1 package was enacted. transfers from the Bundesbank and higher-than-envisaged It was aimed chiefly at providing relief for families with transfers to the European Community (EC) budget. the children and at reducing marginal tax rates and it was to Government decided not to take offsetting measures and to be implemented in two parts: DM 11 billion from 1986 and tolerate a temporary rise in the deficit. As a result of these DM 8'12 billion from 1988. After being returned to office decisions, the federal deficit widened, from its narrowest in January 1987, the ruling coalition agreed upon a larger point in 1985. by almost DM 13 billion to DM 36 billion package of tax reform and reduction (coupled with a reining ( 13/4 percent of GNP) in 1988. Deficits at the other levels back or tax preferences) that became fully effective in 1990 of governmentrose too: thus. the general government deficit (see Table Al6 in Chapter 11). increased to DM 45 billion (2 percent of GNP). The expansionary fiscal policy stance. combined with an accommodating monetary policy. contributed to rapid growth International Concerns: Tackling the of domestic demand in 1986-88. The progress in external External Surplus adjustment. however. was limited. The reduction in the real external balance that took place in 1986-87 was more A prominent fe ature of the present economic upswing than offset by improvements in the terms of trade. so that in the FRG has been the emergence of a large external the external CUITent account surplus increased substantially. surplus. This was the result. first, of export-led growth When the terms of trade stabilized in 1988, real exports in 1984-85 and. second. of the large terms of trade gains rebounded and prevented the current account surplus from in 1986-87 in the wake of the appreciation of the deutsche declining. mark and the fa ll in oil prices. Following the Plaza Agreement in the fall of 1985 in which the Group of Five countries committed themselves to work toward a On the Eve of GEMSU controlled depreciation of the U.S. dollar. greater pres sure was put on the FRG to adopt policies that would In 1989, fiscal policy returned to the consolidation of boost domestic demand. An expansion of domestic government finances. A DM 8 billion increa e in indirect demand in countries with external surpluses was consid taxes. enacted in 1988. together with tlscal drag, resulted ered desirable to take up the slack in the world economy in a negative fiscal impulse from the revenue side. This that was expected to result from a reduction in U.S. net contractionary impulse was reinforced by a withdrawal imports. These considerations temporarily influenced the of stimulus from the expenditure side at the general conduct of economic policy in the FRG. government level as the savings from a reform of the In 1986-87. fiscal policy turned expansionary. though health system more than offset higher expenditures of this wa� more the result of the tax reform already enacted the territorial authorities. As a consequence of this and than a response to international pessuresr . The response the buoyant economy. the general government accounts of fiscal policy to the macroeconomic environment was, showed a surplus for the first time in 15 years; the deficit however. more evident in decisions taken in 1987-88. of the territorial authorities declined to its 1985 level: At a meeting of the Group of Six in early 1987 (the and the federal deficit fe ll to its lowest point during the Louvre Accord). the German authorities agreed to bring present upswing. Thus. fol lowing slippages in 1986-88. quantitative consolidation seemed to be back on track. "' For more information on this and the following sec Lcslie Lipschitz The prospect of somewhat higher deficits in 1990 did ami lllhcr�. Tile Ft•th•ml Republic of G<'rmuuy: Adjustmt'/11 in 11 Surplu.� Cmmtrl'. IMI· Occa;.innal Paper. No. 64 (Wa�hington: lntcrna1ional not imply a permanent weakening in the quantitative Monetary hmd. J:muary 19l591. consolidation effort since the increase in deficits was
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©International Monetary Fund. Not for Redistribution XII • FISCAL AND STRUCTURAL POLICIES IN UNIFICATION expected to be temporary and reflected a major step For 1990, budgetary decisions in the FRG were toward qualitative consolidation of government fi originally determined by the Government's medium-tern1 nances.17 fiscal program that foresaw the implementation of the Progress in the area of qualitative consolidation. on third and largest part of the three-step program of tax the other hand. continued to fall short ofthe Government's reform and reduction with effect from January I, 1990 objectives. There were achievements in tax reform, (see footnote 17). But the changing political and economic privatization of federal government holdings in private environment soon began to leave its imprint on fiscal industry. reform or the public health and pension insur policy.12 During 1990, the Bundestag enacted three ance systems, and in reducing some of the rigidities in supplementary federal budgets primarily aimed at sup the tabor market. Further reforms in business taxation18 porting the economic unification process; additional were also planned. but in other areas, such as privati borrowing related to east Germany totaled some DM 33 0 zation, 19 subsidy reduction,2 and deregulation, 21 much billion. Moreover. the Federal Government and the remained to be done. Uinderestablished an extrabudgetary fund (Gem1an Unity Against this background. the question arises as to what Fund) with a total endowment of DM 115 billion to extent GEMSU will affect the future course of fiscal provide assistance to the GDR Government in 1990- policy, in particular whether qualitative consolidation 94.23 Of the total, DM 95 billion would be raised in the can be completed and how the goal of quantitative capital market (including DM 20 billion in 1990) and consolidation will be affected. DM 20 billion would come from the federal budget.24 As the economic integration of the two economies proceeds, additional pressures on government budgets Fiscal and Structural Policies in GEMSU seem likely. Many of the req uests for government assistance will be justified with the need to support
From the fiscal perspective. GEMSU came at a very economic adjustment in east Germany. 25 However, as favorable time. Government finances in 1989 were in a the experience in the FRG during the 1970s and 1980s strong position and several major fiscal reforms had been has demonstrated, there is the risk that financial support successfully implemented. As a result, there was scope for economic adjustment tends to extend the adjustment for fiscal support of the economic unification process. period and in the event to become entrenchecl.16 The While this was fortunate. there was also the danger that experience of the 1950s and 1960s, on the other hand, the by and large satisfactory state of government finances suggests that adjustment can occur quite efficiently when could invite overly generous fiscal support. the Government limits its involvement in the economy. The following points seem to be of particular impor tance. First, rapid economic adjustment and growth can
11 On January I. 1990. the third step of tax reform took effect that be successfully achieved without subsidies to industries included an estimated reduction in income taxes by OM 39 billion. coupled in 1955. real per capita GNP growth reached a high of with a reduction in tax preferences equivalent to OM 14 billion (Table I0'/2 percent, while subsidy payments reached a low of A 16 in Chapter 11). The tax reform package of 1990 thus implied a net only '1 of I percent of GNP. one tenth of their level of the tax CUI or DM 25 billion. bringing total net tax relief granted in the 1986- 4 90 tax reform program to about OM 50 billion (2'12 percent of GNP). For mid-1980s. In fa ct, as the experience in later years has a more detailed discussion of the tax reform see Lipschit;o: and others. demonstrated, subsidies may well be counterproductive ibid. '" Although tax reform provided some tax relief for businesses (inter alia through a reduction of the top marginal rates of income and corporation . taxes). the Government intended to implement a business sector tax refornl :u Sec Chapter 11. section on "Fiscal Implications of GEMSU .. in the next legblative period in time for the completion of the EC internal n The prime purpose of keeping the bulk of transfers to the GDR off market at the end of 1992. budget was to facilitate continuation of the present system or financial " The Federal Government had completed its privatization program but relations between the Federal Government and the Uinder, as well as little privati7.ation had occurred at the state and municipal levels. between the Uinder, until the end of 1994.
�" In 1989. subsidy p 170 ©International Monetary Fund. Not for Redistribution Fiscal and Structural Policies in GEMSU because they reduce the pressures for adjustment and thus on microeconomic grounds before GEMSU. ln the case of tend to preserve existing economic structures. Second, the FRG, there are a number of government subsidy although a social safety net is important to increase the programs that fit into this category, including those related public acceptance of economic restructuring. care should to the "costs of division.·' In 1990, the territorial authorities be taken to limit the adverse effects of social transfers on are estimated to support West Berlin and the areas negatively the flexibility of the labor market. lt is noteworthy that in affected by the inner-German border by about OM 27 billion 1955 social transfers relative to GNP amounted to only a in the form of transfers and tax exemptions (OM 13 billion little more than two thirds of their 1985 value. Third, in direct transfers from the Federal Government to the West policymakers should be careful that the pursuit of equity Berlin budget and OM 14 billion in subsidies for enterprises through the tax system is balanced against efficiency losses and workers active in Berlin and the other areas)Y Clearly. that might ensue. Direct taxes, which have grown markedly with the lifting of the inner-German border, the rationale since the 1950s, may, if excessive, seriously impair work for this support will disappear. The phasing-out of these incentives. However, in interpreting the experience of the tax preferences and transfers would go part of the way 1950s, one needs also to bear in mind that circumstances toward financingthe integration of the east German economy and expectations at that time differed substantially from into the expanded Federal Republic. There are. moreover. those that now constitute the environment for GEMSU. numerous other subsidies and transfers the reduction of The question arises: Should fiscal policy be used to which would make economic sense even without GEMSU. moderate some of the demand pressures emanating from Considerations outlined above suggest that the Govern GEMSU, including those related to budgetary assistance to ment should be very cautious in tailoring new taxes simply east Germany? A review of the historical experience urges to the financing needs of GEMSU: if new taxes are caution in using fiscal policy for demand management. The unavoidable, they should. at least, be consistent with the problem lies not so much in the principle of demand Government's ongoing tax reform program. Moreover, to management-indeed, gains from well-designed and timely the extent that the adverse effects of GEMSU on government policies are likely-but rather with the practical problems finances are projected to be temporary, it might be unwise of implementation. There is, of course, the usual problem to allow revenue increases to become embedded in the of timing-because of lags in implementation, policies fiscal structure. However, a tax measure perceived as designed to be anticyclical can turn out procyclical-this temporary may result in a particularly large offset in private was evident from the experience of the FRG in the late saving behavior. 1970s. Moreover, even when implemented, there can be The case against a tax increase in the FRG rests on the significant lags before policies have their full effect rise in the deficit being limited and temporary and the evidence presented in Chapter IX indicates. for example, spillover effects of rapid demand growth in east Germany that the effect of increased government saving on national remaining manageable. It is clear, however, that the outlook saving may be offset to quite a large extent by reductions for the government finances in east Germany is highly in private saving, at least initially. But more fu ndamentally, uncertain and that one could envisage large fiscal imbalances there is a danger that the measures used to achieve stabi being sustained for some time. It may also turn out that lization objectives have long-run adverse effects on the past experience, on which model calculations of the effects structure of the budget and the allocation of resources in of GEMSU are based, is a poor guide given the unprece the economy: the microeconomic effects of tax and ex dented character of the unification process. These factors penditure changes may not be given much attention in the argue for a close monitoring of developments in Germany face of pressing stabilization objectives, and tax changes and their international effects. Should persistent and sizable which generate revenue initially for stabilization purposes fiscal imbalances seem likely, policymakers should be ready can, in the long run, fuel ill-considered expenditure pro to take decisive action. grams. In the event that fiscal measures are needed to offset 27 In addition. the territorial authorities are estimated to spend about some of the expansionary effects of GEMSU, the first OM 7'12 billion and the social security system roughly OM SV2 billion to priority should be to take actions that were already warranted ease the consequences of the division of Germany. 171 ©International Monetary Fund. Not for Redistribution