V
East Germany The New Wirtschaftswunder?
Donogh McDonald and Gi.inther Thumann
Introduction
The regional imbalances that characterize many ad in west Getmany; it is assumed that labor productivity vanced industrial economies have long frustrated eco in west Germany will increase at about 2V2 percent a year nomic policymakers. The large gaps in our understanding or cumulatively by close to one third between 1990 and of these imbalances prompt the question: Will the evo 200P lution of the east German economy over the next decade To provide some perspective on the present size of the reveal a new economic miracle-Wirtschajiswunder-or productivity gap, Table I contains information on produc the emergence of another regional problem within the tivity differences between regions of the Federal Republic European Community? On the one hand, the saving of Germany (FRG) in 1987.3 The Lander in the FRG are surplus in west Germany provides a large pool of arranged into three groups, ranked according to output per resources from which the investment needs of east capita and productivity levels. The third ranked group Germany can be financed. Moreover, the tradition of (comprising Rhineland-Palatinatc, Lower Saxony, and enterprise in the eastern part of the country was strong Schleswig-Holstein), which had a population of some before World War IJ and it may be possible to revive 13 million in 1987, had an average productivity level about this tradition quickly. despite its long suppression by the 13 percent below that of the FRG as a whole and 18 percent system of central planning. On the other hand, given the below that in the other eight Lander. present dearth of capital in east Germany, it will be some Against this background. two scenarios for east Germany time before west German wage levels can be supported are illustrated (see Chart 1).4 In scenario A rapid growth in the east without large-scale subsidies or substantial boosts productivity levels in east Germany to 80 percent of unemployment. This creates obvious tensions. While a the west German level by the year 200 I. Unemployment slow closing of the earnings gap might result in a is initially high-one fourth of the labor force in 1991- migration of the most skilled to the west, a premature bur falls rapidly and by the end of the scenario is at about narrowing of the gap could well discourage investment: the same level (6 percent) as in the baseline scenario for either might endanger the process of economic recovery west Germany . The investment needs in this scenario are in the east. large: ln 1991-92 gross investment averages DM 110 billion To highlight some of these issues, this chapter presents a year (43 percent of GDP).5 This invesrment is financed scenarios for east Germany during the first I I years of entirely by external resources (i.e., resources from outside unification ( 1991-200 I) under alternative assumptions east Germany, including fiscal transfers from west Ger as to how quickly the productivity gap between east and many); indeed, external resources amounr to about 150 per west Germany is nan·owed.1 The scenarios take as their cent of net investment. Over the period 1991-200 I as a starting point a profile of the economic situation in east whole, total net investment is of the order of DM IV" Germany in the second half of 1990, incorporating official trillion, equivalent to two thirds of west Germany's net fiscal projections and the assumption that, immediately national product in 1990, with three fourths of this net prior to German economic. monetary , and social union investment financed from outside east Germany. 6 The (GEMSU), underlying labor productivity in the east was about 30 percent of the level in west Germany. The 2 Further details of the underlying assumptions arc given in Chapter IV. section on ..Supply Conditions in West Gcnnany:· growth rates required in the east to narrow the productivity ' Of course. to the extent that these productivity differences were gap over the next decade depend not only on the size of due to structural weaknesses in the poorer Uinder. they renected the initial gap but also on the increase in labor productivity problems one might hope to avoid in restructuring the east Gennan economy.
• The model used is described in the follow ing section . � All deutsche mark ligures are in terms of 1990 prices. Unle�� ' The duration of the simulation wa> chosen to allow ten yeasr of otherwise indicated . all ratios to GDP relate to GDP in east Germany. investment to inlluencc the terminal productivity level. Investment in '' The calculation of the investment needs to reach a relative 200l is assumed to have no innuence on productivity in 200 l. prod uctivity level of 80 percent by 200 l reported in Chapter IV was
78
©International Monetary Fund. Not for Redistribution Introduction
Table I. Federal Republic of Germany: Regional Profile of Output and Employment, 1987
Output Output Unemployment per per GDP Population' Employment ' Rate' Capita Worker (In billions of deursche mark) (In millions) (In percenT) (FRG = 100)
Hamburg 91.7 1.6 0.7 11.6 175 178 Brcmen 27.5 0.7 0.3 12.8 1 27 135 Berlin ( Wesll 76.2 2.0 0.9 9.2 115 110 Hcssc 203.4 5.5 2.5 5.7 112 109
B;u.Jcn· WurHembcrg 322.5 9.3 4.4 4.6 106 99 Bav
Rhineland-Palatinate 1 05.7 3.6 1.6 6.7 89 90 L Total 2009 .1 61.1 26.9 7.2 100 100 Top four Liinder 398.8 9.8 4.4 7.9 124 122 Middle four Liinder 1238.4 38.0 16.8 6.7 99 99 Bottom three Liinder 37 1 .9 13.3 5.7 !U 85 87 Source: Statistisches Bundesanu. Srmisrisches Jahrbuch. 1989. ' Population and labor market dal:l as of May 25. 1987. declining recourse to external saving over time reflects, in scenario the primary fiscal deficit in east Germany is of the part, falling investment requirements in relation to output, order of 9 percent of GDP. Larger accumulated deficits but, more important, a rising saving rate. Private saving also increase interest payments.� Given these fiscal devel increases, but the principal source of the stronger external opments, the imbalance in the external accounts throughout position is the improvement in the government accounts. the scenario is also much larger than in scenario A. The general government deficit in the east is initially very Scenarios A and B are discussed in greater detail in the large (50 percent of GDP in 1991), principally on account following sections. In interpreting these scenarios. one of substantial government dissaving. Over time, the deficit should bear in mind the uncertainties surrounding the initial drops steadily. with a small overall deficit and a primary conditions in east Germany, the likely response of fo reign budget surplus by the end of the scenario. 7 investors, prospective migration patterns. the ability of east Scenario 8 is less optimistic, with productivity in 2001 Germany to absorb large-scale investment (particularly in only 60 percent of that in west Germany and migration the initial years of GEMSU), the policy and institutional from east to west occurring on a much larger scale. The framework, and the behavior of economic agents. Moreover. weaker economic performance results from lower invest as noted above, there are large gaps in our knowledge of ment and a slower reduction of inefficiencies in the use of the factors that promote rapid growth in some less developed labor and capital. Net investment in 1991-92 is only regions but allow others to languish alongside rich neigh 60 percent of that in scenario A, and this relative weakness bors. Thus, it is important to look at scenarios A and B of investment persists throughout the scenario as the initial not as projections but as providing a consistent framework hesitancy of investors is reinforced by aggressive wage within which issues related to GEMSU can be explicitly demands and by ingrained structural weaknesses in the examined. Some of these issues are brought up as details economy. The fiscal imbalance declines more slowly than of the scenarios are presented, with a more wide-ranging in scenario A as low growth restrains revenue and boosts discussion following in lhe final section of the chapter. social expenditure relative to GDP; by the end of the While the two illustrative scenarios produce what are in many respects quite different outlooks, a common feature lower a� it did not include investment in the year 2001. The share is that they both imply rapid growth rates; in scenario A, financed by external resources is sensitive to the assumption on fiscal output grows at a rate of I 01/2 percent a year and labor transfers from west Germany. In this chapter. it is assumed that fiscal productivity at a rate of 11 percent, while in scenario B transfers cover government dissaving in the east. See footnote 26 for Y2 further discussion. 1 For analytical purposes. fiscal operations in east Germany have been separated from those in west Germany. lt is also assumed that • Given the assumption on fiscal transfer� from west Germany. there arc no changes in tax rates or in the rules governingthe operations larger interest payments resulting from greater government dissaving of the social insurance funds. in east Germany are recorded in the fiscal account� of west Germany . 79 ©International Monetary Fund. Not for Redistribution V • EAST GERMANY: THE NEW WIRTS CHAFTSWUNDER? changes in employment. In scenarios A and B, all but Chart l. Scenarios for East Germany, 1991-2001 one of these variables are used as inputs into the model, the exception being employment, which is determined 20 40 Output growth1 Unemployment2 interactively with wages. The model is structured so as 35 to allow wage levels to reflect profit maximization in an environment of well-functioning factor markets; that is, 30 for a given level of employment, there is a warranted real wage. However, in the early years, wage income is 25 allowed to exceed this notional equilibrium. This might 20 be the result of employers being off their profit maxi mizing labor demand schedules;10 alternatively, institu 15 tional factors might provide those employed in certain sectors with substantial protection from the operation of 10 competitive forces. There is no explicit link in the model 5 between labor markets in the eastern and western parts 1993 1995 1997 1999 2001 1991 1993 t995 1997 1999 2001 of Germany. However, the two scenarios presented differ 60 in the scale of migration, with larger westward migration General government in the less optimistic scenario. tl primary deficit4 50 The assumptions on labor income outlined above are a key element in the development of household disposable 40 income. The extent to which income from capital is 30 distributed is also of importance. In broad terms, the distribution rate is set low initially, reflecting the high 20 degree of public ownership and the need to retain earnings to finance investment and restructuring expenditures. 10 Over time, the distribution rate increases but still remains 0 below the west German level at the end of the scenario. Taxation and social transfers are determined within the legal framework adopted under the State Treaty on GEMSU. Given the relatively low initial level of income ' Percent change in real net domestic product. For 1991. growth is in east Germany, the average tax rate on wage income measured using output in rhe second half of 1990 as a measure of the is significantly less than that in west Germany: it rises underlying value of output for all of 1990. See footnore 23 in the text. quickly with income growth but remains lower than in 2 In percent of the labor force; including the effective period of unemployment for those on short-time work. the west as long as wage levels are lower. Transfer 3 Net imports of goods and nonfactor services. in percent of GDP, at payments to households are related to caseload (e.g., 1990 prices. number of unemployed) and, for unemployment and • Overall deficit, excluding interest payments, in percent of GDP. at 1990 prices. pension benefits, wage levels in east Germany. In addition to fiscal operations that take place within the usual framework of the general government accounts, the output and productivity growth rates are 61/2 percent it is important also to consider the operations of the and 9 percent, respectively.9 The challenge over the next public Trust Fund (Treuhandanstalt). The calculations ten years is clearly fo rmidable; in Box I, it is put in a of the Trust Fund's financial balance are on a national historical context. accounts basis incorporating dividend receipts, interest payments, and capital transfers to enterprises. Asset The Model transactions related to privatization, the amortization of The supply side of the model has already been outlined '" One can imagine a number of reasons for this. For example, in Chapter I V (see section on ''A Supply-Side Framework much of the economy will remain in public or cooperative ownership and this may moderate the extent to which profit maximizing criteria for East Germany''). As discussed there, the key elements are used. Employers in new enterprises may also be willing to pay are capital accumulation, improvements in the general above the ··going wage" to engender good labor relations or, in the and tabor-specific efficiency parameters (g and h), and case of investors from outside of ca�t Germany. because of pressure from unions at the home base of the investor. '' The underlying trend of the labor force in east Gem1any is based 9 The larger gap between output and productivity growth rates in on demographic projections (see Deutsches lnstitut fiir Wirtschafts scenario B re flects the assumed scale of westward labor migration. forschung, Wochenbericlu. 23-24/90. June 14. 1990. pp. 315-21). lower labor force participation, and higher unemploymenr in this and the assumption that the female labor force participation rate. scenario. presently significantly above the rate in west Germany. will decline. 80 ©International Monetary Fund. Not for Redistribution The Model Box 1. The Scenarios in Historical Context i To help place the challenges facing east Germany in It sworth noting that with higher investment, the Japanese some historical context, the table below presents data for economy grew at an average rate of 9 percent over the period key macroeconomic aggregates in the FRG in the 1950s. 1955-73. In the 1960s, growth in Japan was even fa ster at Between 1950 and 1960, real net domestic product in the IOI/2percent on average with labor productivity rising at a rate FRG grew at an annual rate of 8V.. percent, and with of 8314 percent. Moreover, these latter growth rates were, employment growing at about 21/. percent, the annual growth presumably, achieved from a base (1960) that was not char of labor productivity was just under 6 percent. While these acterized by the scale of inefficiency in factor use that presently figures are im pressive, it is noteworthy that the growth of prevails in east Germany. output and labor productivity in scenario A is much larger. Historical experience, however, is unable to give clear i However, one should be careful when making such compari guidance on the scale of investment that can be absorbed n sons. First, labor hoarding and general inefficiency in factor relation to output. Whi le the proximity of suppliers of capital use in the FRG in 1950 may not have been as large as those goods as well as the general slack in east Germany's economy believed to prevaiJ in east Germany at the time of GEMSU. mjgbt be expected to enhance its ability to absorb investment, For example, unemployment in the FRG was 11 percent of the investment ratios envisaged in scenario A in the initial the dependent tabor force in 1950 and declining, whereas in years of GEMSU are quite largo-in Japan, gross fixed east Germany, prior to GEMSU, there was hardly any open investment was close to one third of GNP, on average, over unemployment but the undeitying unemployment rate was the period 1�80, with a peak investment ratio of36 percent some 25-35 percent of the labor force according to scenarios in 1973. More generally. one needs to be cautious in using A and B. Improving the efficiency of factor use in the east historical comparisons given that the political and economic German economy is expected to be an important source of circumstances of east Germany are so different. Indeed, the productivity gain in the coming years. situation in east Germany is unique in many respects. First, the Second. the investment ratio in the FRG in the 1950s was political imperative toclose the productivity gap between west not unusually large. On average, gross fixed investment was and east Germany would seem to favor the prospects for large 22 percent of GNP, sustaining a rate of growth of the net investments in the east. Second, expectations of rapid income capital stock of 7¥.. percent a year. These investment ratios do gains may influence wage demands and investment incentives; not suggest that the FRG's economy was reaching the limits more modest expectations undoubtedly prevailed in the FRG of its ability to physically absorb capital; investment ratios in the 1950s and in Japan in the 1960s. Furthermore. the were higher in the FRG in the 1960s as they were in many system of social protection in east Germany over the next other industrial countries. Nor was the FRG straining its decade is likely to be more comprehensive than that in the investable resources in the 1950s: the FRG ran an external FRG in the 1950s. surplus which averaged 4 percent of GNP (on a national accounts basis) over the period. Federal Republic of Germany: Selected Data from the 1950s Gross House- Real Net Labor Real Net Fixed hold Unemploy- Domestic Employ- Produc- Capital Real Foreign Invest- Saving ment Product ment tivity Stock Wages' Balance� ment Rate3 Rate• (Annual changes in percent) (In percent of GNP), (/n percelll) 1950 2.0 18.9 4.3 u.o Period averages: 1951--(i() 8.3 2.3 5.8 7.7 5.7 4.2 22.1 7.7 5.7 1951-55 9.8 2.8 6.8 7.0 6.5 4.9 20.8 6.7 8 .3 1956--60 6.8 1.8 4.9 8.4 4.9 3.5 23.4 8.6 3 1 i Sources: Deutsche Bundesban.Jc, 40 Jallre Dewsche Mark: Monetare Statistiken, 1948-1987 (1988); and Statistsches Bundesamt, Volkswirtschaftliclle Gesamtrechnungen. ' Nominal wages deflated by the consumer price index. 2 National accounts basis; eJCcludes transfers. 3 Bundesbank definition. • In percent of the dependent tabor force . s In current prices. 81 ©International Monetary Fund. Not for Redistribution V • EAST GERMANY: THE NEW WIRTSCHAFTSWUND£R? Table 2. East Germany: Key Supply-Side Elements of Scenario A Relative to FRG (FRG = I) Growth Rates' 19902 2001 1991' 1992-94 1995-97 1998-2000 2001 1991-2001 Net domestic product at factor cosr' 0.09 0.20 7 15 11 8'/2 7 10'/z Employment� 0.29 0.25 - 151/z 2Y2 - '12 -I - Labor force 0.29 0.25 21/z -I -'1> - Y> - •;, -I Unemployment rate" l7Yz 11 8 6112 6 Adjusted unemployment rate7 261/1 121/2 8 6Y2 6 Net emigration (in thousands) 100 23 Output per worker' 0.31 0.80 27 12 tt 9 7'12 IIY2 Net capital stock' 0.09 0.17 41/2 11y, 11 10 9 10 Net capital per worker 0.29 0.69 24 9 11 JO 9112 11 Gross compensation per worker 0.44 0.76 8 6'h 7Yz 91/1 8'h 8 General efficiency factor (g) 0.80 J.OO 5 2'h 2 I 'lz '12 2 Labor-specific efficiency factor (11) 0.67 1.00 12 5'12 21/1 l'h 3'12 Source: Authors· calculations. 1 In percent a year. rounded to the nearest '12 of I percent; except for the unemployment rate. which is the annual average for the period specified. in percent of the labor force. and migration. which is the annual average in thousand�. 1 Second half of the year at an annual rate. J Relative to the second half of 1990. with data for the second half of 1990 on an annualized basis. Sec footnote 23 in the text. • In constant 1990 prices. ' Including those on shon·time work. • In perce�t of the labor force: includes only full-time unemployed. 1 Adjusted to incorporate the degree tO which pan-time workers are unemployed. debt, and compensation of the former owners of property price takers in the larger German and European markets. expropriated by the Government of the GDR, are included output will be determined by supply-side conditions. For "below the line''; they, thus. do not influence the the initial years of the scenarios, however, this is not a financial balance but do affect the gross financial debt reasonable assumption. A feature of the demand pattern of the Trust Fund. The Trust Fund is assumed to have that has just been discussed is that relative prices play an initial net worth of DM 100 billion.12 no explicit role in the model in allocating domestic and On the demand side. private consumption is related fo reign demand between domestic output and foreign to developments in disposable income and the behavior output. This is not because relative prices are believed of the household saving rate. Government consumption to be irrelevant but rather that the large market disequi is assumed to decline relative to GDP over time, in light libria that are likely to exist in the initial stages of of its very high initial level. Investment is detern1ined GEMSU and the marked shifts in the composition of by the path for the capital stock. which in turn is related supply and demand make it extremely difficult to judge to the productivity target. The difference between supply what the degree of substitutability might be. Implicitly, and domestic demand represents the net foreign balance it is assumed that, in the initial stages, output and demand on goods and nonfactor services. elements of the scenarios have been made consistent by An important question is how the demand and supply a combination of relative price adjustment and disequi sides of the model are made consistent. Over the medium librium quantity adjustment. This issue is discussed to long tenn, with east German producers likely to be further below; taking note of it at this stage serves to underline the illustrative nature of the scenarios. '2 The initial endQwment of the Trust Fund is ba�ed on the estimate of the capital stock in the economy. using sectoral shares for west Germany to distribute the east Gennan capital across sectors-only Starting Conditions the industrial sector is attributed to the Trust Fund. lt is assumed that most of the initial debt of the enterprises is offset by the value of land holdings. Initially the value of the endowment is below potential The base for the scenarios is the second half of 1990. owing to the general inefficiencies in the economy. Over time. the Key elements of the starting position are presented in cfliciency of the enterprises in the Trust Fund does not increase as fast as that of the economy as a whole, as the firms experiencing the Tables 2-4, with all data for 1990 referring to the second largest efficiency gains arc privatized. half of the year on an annualized basis. On the supply 82 ©International Monetary Fund. Not for Redistribution Starting Conditions Table 3. East Germany: Demand Pattern Under Scenario A !Period averages) 19901 19911 1992-94 1995-<)7 1998-2000 2001 (In billions of dewsthe mark) (Pernmt change a year) GDP' 216 9 141/2 11 !W> 7 Dome>l ic demand 332 9 7 611> 5'12 5 Pri vale consum pi ion 180 4 5'/, 61/, 51/2 5 Govcmmcnl consumplion 78 -81h 4111 3 21/2 2112 Gros' fixed invcs1mc111 73 40 11 81/2 7 6 Hou�cholu dispo��blc income J90 2'1, 61/! 71/, 7 6 (Sul'in.� rot<•) s 31/, 1'/. , 7 IO'h 12'1, !In billions of 1990 dewsclre mark) Foreign bal;111cc on good� and nonfaclnr 'crvicc� - 116 - 1 27 - 101 - 71 - 31 -5 (In percc>m o{ t'tiSt German COP} - 54 - 54 -33 -16 -6 -I Currcnl :occoulll' -23 - 51 -66 - 72 - 74 - 70 (In Jl<'l"l'l'/11 cJf't•ust Gemwn CDP} - 11 -22 -21 - 17 - 1 3 - 11 Gross nalional saving' -44 - 25 22 74 1:\l:) 184 (In (Jl'rl'l'lll of <'tJst German COP) - 20 - 11 7 17 24 28 Gro,� invcMmcm 74 104 130 1 68 208 234 (In percent of east Gemum GDPJ 34 44 42 38 37 :16 Fi>e:al lran,f.: r' frnm wc,l Gcm1any 95 78 -12 _? .)' -3 - 19 (/n percent of eost German GDP) 44 33 14 5 - I - 3 Ncl cx1cmal liabililics'' J3 84 21-1 426 647 789 (In pernmt of c•ast German GDP} 15 35 67 97 114 120 MenuHwulwn item.\' (in percent of <'list German GDP): Currenl accounl !Excluding liscal lransfcrs) -55 -55 -35 -22 - 13 - 8 Scc1oral linancial balance' Hou�chold� 4 3 3 4 6 7 Emerpri,cs• - 9 -13 - 15 - 14 -14 - 14 General govcmmcnl -50 - 45 -23 -12 - 4 - I Source: Author�· c�licul:uion�. 1 Second half of 1990 on an :tnnualizcd basis. � Pcrccn1 change> arc rcl;uive 10 1he ;ccond half of 1990. wi1h 1he second half of 1990 expressed on an annualizcd ba�i>. Sec foo1no1c 23 in 1hc 1ex1. 1 Difference� bc1wccn GDP grow1h and lhe grow1h of nc1 domes1ic product in Table 2 rcOec1 principally 1he influence of the changing share of nc1 indirCl'l !aXes in GDP. ·' Including balance,; on 1ran�fcrs and inveMmenl income. The balance on inve�lmcnt income include;, all properly income (nel nl lax) auribuwble 10 nonrc�idems. including rewined earning' of enterprises owned by nonrcsidems. ' Excludes lbcal Iran, fer� from wc,l Germany. " Enu of year. or average of end-of-year data for group; of years: reprc�enl� 1he inilial debl level piu;. I he cumul;uion of lhc cxlcrnal currcnl accounl dcfici1. ' All inveslmclll income auribuwhlc 10 nonresidcnb is 1rca1cd as an oullay. including relained earning' or etllcrprisc, owned hy nunrc,idcn". side of the economy, it is assumed that, on the effective The above characterizes the supply-side position on date of GEMSU. productivity in east Germany was 30 the eve of GEMS U. For the second ha! f of I 990. it is percent of the west German level. in terms of output assumed that there is no increase in the underlying value that could be prolltably sold in open markets. The factor of output13 but tabor productivity rises as some dis inputs and factor efficiency underlying this output level hoarding of tabor occurs. Wages are considerably higher are taken from Table 3 in Chapter IV. using the central than warranted by supply conditions. owing in part to IJ case (8.11) from that table. According to those calcula recent large wage awards, and absorb 90 percent of net tions, capi tal per worker in east Germany was 28 percent domestic product. or the level in west Germany but, owing to a general 20 The base for the demand projections is derived from percent inefficiency in the use of factor services, effective the assumptions made about labor income and investment capi tal services per worker were lower. Labor was also inefflciently used; apart from the below potential use of 1 1 Outpul as measured by oflicial statistic� b likely 10 fall ,ubswn labor servicel': due to the general economy-wide ineffi lially. Sec Chap1er Ill. 'cclion on "Rcccnl Economir SiiUalion." for a dbcussion of oulptH devclopmcnls alkr GEMSU look cffccl. ciency labor services were also effective I y reduced by . 1" Sec Chap1cr Ill. scclion on '·Rccclll Economic Silllallon." for a large labor-specific inefficiencies. discussion of wage tlevclopmcnl;. in lhc early mcm1h� uf GEMSU. 83 ©International Monetary Fund. Not for Redistribution V • EAST GERMANY: THE NEW WIRTSCHAFTSWUNDER? Table 4. East Germany: Government Finances Under Scenario A (In percent of GDP in cast Germany, period averages) 1990' 1991 1992-94 1995-97 1998-2000 2001 General government balancel -50 -45 -23 -12 -4 -1 Revenue 39 41 41 39 39 39 Tax revenue 39 40 39 37 37 37 Income and corporate taxes 3 4 5 7 9 10 Social security taxes 16 18 19 17 16 16 Indirect taxes 19 18 15 13 12 11 Nontax revenue I I 2 2 2 2 Expenditure 90 86 64 51 43 41 Current expenditure 83 74 54 43 JR 36 Consumption 36 30 25 20 16 15 Social transfers 35 34 22 17 15 15 Unemployment 13 12 4 3 2 2 Pensions 11 12 10 9 9 9 Other 10 10 7 6 5 4 Interest 2 2 3 3 4 4 Other 9 7 4 3 3 3 Capital expenditure 7 12 10 7 6 5 Fixed investment 5 9 8 6 5 4 Transfers 2 3 2 2 I Trust Fund balance -9 -13 -I Fiscal transfers from west Gcnnany 44 33 14 5 -I -3 General government debt-' 26 36 47 56 62 64 Trust Fund debt' 9 32 16 4 Memorandum irems: Total interest. including interest in west Gcnnan fiscal accounts" 2 4 8 10 10 9 General government balance, including interest in we$! Gern1an fiscal accounts -50 -46 -28 -18 -11 -7 General government debt. including debt registered in west Genmtn fiscal accounts'.s 48 89 118 134 131 123 Source: Authors· calculations. ' Second half of the year on an annualized basis. 0 National account� basis: excluding fiscal tran�fers from west Germany . 1 At year-end. or average of end-of-year data for groups of years. � Interest in the west German accounts related to financing fiscal transfers to cast Germany. < Debt incurred in the west Gem1an fiscal accounts related to llnancing llscal transfers to east Germany and the associated interest costs. The debt level at the end of 1990 renects rhe initial debt level assumed for July I, 1990 and the borrowing requirement in the second half of 1990 (i.e .. at half of the annual rate implicit in the column for 1990). and from official projections for the government finances. of OM I = M I). though this involves a significant Private disposable income is initially high relative to increase in quality. Moreover. given that the underlying GDP, reflecting the size of the labor share, large social value of output is much lower than implied by official transfers, and the low rate of direct taxation. Assuming estimates of production under the former economic a household saving rate of 5 percent, private consumption system, this level of investment represents a substantial absorbs about 83 percent of GDP. compared with 54 share of GDP (34 percent). The high levels of consump percent in west Germany. Government consumption is tion and investment relative to output result in a large also assumed to be higher than in the west (36 percent external deficit in the second half of 1990 financed in of GDP compared with 18 percent).'5 Thus, in total. part by fiscal transfers from west Gern1any. The decom consumption expenditure represents 120 percent of GDP position of this imbalance shows that it is mostly and an even larger percentage of national income. The accounted for by the general government deficit. assumed value of investment is about the same (on an In the construction of the scenarios, it has been assumed annual basis) as in 1989 (converted at an exchange rate for analytical purposes that east Germany retains a full range of government institutions. including those ab '' The assumption:. on government finance> are discussed in greater sorbed by the Federal Government at the time of political detail below. unification. This separation of fiscal accounts can be 84 ©International Monetary Fund. Not for Redistribution Scenario A seen as a device that facilitates the examination of the The outcome of these assumptions is a general gov effects of the integration process on the combined fiscal ernment deficit (on anational accounts basis) equivalent position of cast and west Germany. The starting fiscal to one half of GDP in east Germany in the second half situation in the east is constructed so as to be consistent of 1990. In addition, the Trust Fund runs a deficit of with official projections for the fiscal effects of GEMSU 9 percent of GDP, as a result of transfers made to in the second half of 1990.16 A central fe ature of the enterprises to promote structural adjustment. It is assumed unification process is that the legal and institutional that the general government authorities in the east borrow structures governing social expenditures and taxes in to finance capital expenditures, with current deficits west Germany have been adopted in the east. However, financed by transfers from west Germany.2 1 The Trust given the differences in the level of income, in the Fund finances its activities by borrowing. composition of demand, in infrastructural needs. and in the previous budgetary systems, the structure of the Scenario A government budget in the east is quite different from that in the west. On the revenue side. total receipts Supply Developments relative to GDP are about 4 percentage points lower than Table 2 illustrates how key supply-side variables might in the west. The yield from income and profit taxes in look in the year 200 I with east German productivity the east is limited as a result of the interaction of tower having reached 80 percent of the west German level. A wage levels with a progressive tax structure and exemp basic premise is that inefficiencies in factor use will have tion levels attuned to west Gennan income levels. been eliminated.22 Over the 1 1-year period. output grows Offsetting this. however. collections of indirect taxes at I OY2 percent a year and productivity at about 11Y2 percent relative to GDP are greater in the east, given the high a year. Improved efficiency in factor use accounts ror a initial consumption level. 17 Potential social security tax large part of the growth rate differential vis-a-vis west receipts arc also above those in west Germany, owing Germany, with the narrowing of the gap in the capital to the large share of tabor income in output in east tabor ratio being the other important factor. Germany; collections are, however, well below this In this scenario, output growth quickly rises to a peak potential as many companies with liquidity problems do and then falls back gradually. 23 The important factors not remit either their own contributions or workers' contributions withheld from wages.'� the assumption that almost all the unemployed arc eligible for either Thus. differences between east and west Germany on benefits or retraining prognuns. Pension benellts arc larger in relation to average incomes than in the west as fe male pensioners receive the spending side are at the center of the government pensions closer to those received by male pensioners. renecting the fiscal imbalance in the east; the ratio of expenditure to high female participation rate that has prevailed in the east. GDP is double that in the west in the second half of " This assumption is in line with the general principle governing finances in the FRG that government borrowing should not be greater 1990.1� In part, this reflects higher expenditure on than capital expenditure. Of course. given that central government infrastructure and capital transfers to enterprises. How operations in east Germany arc within the budget of the Federal ever. the principal difference lies in current expenditure: Government. many of these transfers will take the form of internal accounting transfer5 as the Federal Govcmment collect� much tc�s in public consumption reflects the high employment levels revenue from cast Germany than it spends there. This assumption on that characterized the government sector of the GDR and the financing of governmentexpendi!Urc in the ca�t lws little implication the high cost. relative to GDP. of health services in east for the me 85 ©International Monetary Fund. Not for Redistribution V • EAST GERMANY: THE EW WIRTSCIIAFTS WUNDJ:.'R? determining this pattern arc as fo llows. First. over the initial ployment compensation. Government consumption ex four years . the general erriciency of factor use rises mark penditure drops notably in 1991. as a result of economies edly. particularly in 1991-92. Labor dishoarding occurs in the demand for goods and a reduction in employment. even more rapidly owing to the competitive pressures On balance, total domestic demand grows at about the generated by GEMS U. The growth of the capital stock in same pace as GDP in 1991: the external deficit on goods 1991. which relkcts investment in 1990. is only 4 112 percent. and services, although higher in terms of deutsche mark. but then jumps to a I 1 112 percent rate of increase in is unchanged in relation to GDP. The stability of the 1992-94. The front-loaded growth of the capital stock seen external imbalance conceals shifts in sectoral financial in Table 2 is due to the assumption that major public balances; in particular, the government balance improves expenditures on infrastructure occur at an early stage as a relative to the pe1iod July-December 1990, while the prerequisite for profitable private investment and that con sharp increase in private investment is only partially siderations related to profitability and strategic positioning financed by improved company profits. induce large up-front private investment. Among the factors Over the first half of the 1990s, household income that would be expected to encourage private foreign in expands at a much slower pace than output. reflecting a vestment are lower land prices and an abundant trained smaller rise in wages than in productivity. increasing labor force, which for a number of years is expected to be average tax rates, and reduced growth of social transfers less expensive than that in the wcst.2J (principally due to lower unemployment payments). As As regards employment. the dishoarding of labor is a result. the share of private consumption in GDP falls initially only partially offset by increased demand for labor markedly. In the second half of the decade, with wages services induced by economic growth . with the result that moving more in line with productivity, a rising household the unemployment rate is about one quarter of the labor saving rate restrains the growth of pri vate consumption force in 1991-about two thirds of this is assumed to be relative to GDP. Public consumption also increases more open unemployment with the remainder being in the form slowly rhan GDP. as economies are made in employment of short-time employment. Despite the high unemployment and other cun·ent expenditure. Investment growth grad rate. real wages rise. though at a much lower pace than ually declines through the scenario (reflecting the assumed productivity. Over the next few years. wages continue to time pattern for the growth of the capital stock). but grow less rapidly than productivity under the inlluence of remains the leading factor in the growth of domestic high unemployment and the initial excessive share of labor demand. income in output . Net wages increase more slowly than The external imbalance on goods and nonfactor serv gross wages. as the progressive tax structure boosts average ices in east Germany . which is 5 percent of west German tax rates. With the high investment rate feeding into the GDP in 1990-9 1. declines steadily throughout the scen capital stock. prolitability rising and domestic output be ario. as demand grows more slowly than output. The coming more substitutable with foreign output. labor market foreign imbalance that remains in 200 I essentially reflects conditions improve and the unemployment rate begins a net income payments to fore ign investors. From a saving steady decline. investment perspective. the fall in the external detlcit is due in part to the declining investment demand in relation to GDP. but the principal source is an increase in the Demand Developments national saving rate. In 200 I, the net national saving rate ( J 9 percent of NDP, excluding fiscal transfers from west Following a strong growth of consumption in the Germany) is above the level in the west ( 17 percent) and in second half of 1990. investment expenditure surges is still rising; although the productivity gap has been 1991 (Table 3). The increase in private consumption in narrowed significantly. a large dirference remains in the 1991, on the other hand. is more restrained than that of wealth-income ratios of the two regions.:� 1t should be owing to the re atively moderate growth of output, l noted. however. that this estimate or the saving rate in household income. While gross wage rates rise by east Germany is sensitive to the assumption on fiscal 8 percent. this is offset by de<.:line in the number of a transfers from the west. 26 people employed, and a fall in disposable income is prevented by increases in pension payments and unem- !' The higher saving rate in cast Gcrm;ony i, rellccted in cnlerpri�c saving. used to finance ahc sail! high invc�aonent ratio. "' The intcrc>t co�t> on the borrowin�: 11 1 linance fi>cal tran�fcr;, to 21 The question nf absorptive .:apacily b. however. diflicull iO judge cast Germany arc reflected in the lbc;J accounb in '"-�" Germany. and migha affccl ahc disaribuaion 1\f invcMment in the curly yeasr nf Assuming lo�vcr lisc:ol transfers from wcsa Germany would be Ctluiv GEMSU. The broad aimc pauern nf invc,tmem would ncverthclc�s alcnt to incorponaaing ahc corresponding interest co�l� in lhc ea�! be ..:xpccted to be 'irnilar to th<�l in Table 2. Specifically. over ahc German fiscal accouna�. This would reduce nalional ,aving in ca�l longer run. ;on imi>Ort;mt c:on,idcration in the time protile <)f outpul Germany as a rcsuh of higher external interest payments. From n and ahc capital ,aock i, lhat. a' produc:tiviay cundition> in ahc awo longer-run pcr�pectivc. •>ne migha want to c�aimatc li>cal tran,fcr� and economic> coowcrge. rate� of growth of important macroeconomic ahc di$lribuaion of the ioucre>l cost> bcawecn ca;,l anJ wcsl Germany v<�riublc> such as the capital stock and output should ubo converge. on the basis of who will ultimately pay. Reducing cxpenJiwre in wc>t 86 ©International Monetary Fund. Not for Redistribution Scenario B Fiscal Developments recorded in west Germany's fiscal accounts. fiscal op erations in east Germany still represent a drain on The basic premise of the scenario is that the major government saving. differences in the fiscal structures of east and west Table 4 also contains an illustrative scenario for the Germany will be eliminated over the next decade . In finances of the public Trust Fund. Over time, the Trust cast Germany, the fiscal imbalance (DM 110 billion in Fund finances its operation through privatization and 1991 )27 declines rapidly relative to GDP. almost entirely dividends from the subsidiary holding companies. These because of a falling expenditure ratio. Government receipts are used to service the Trust Fund's debt, make consumption expands less quickly than output as manning capital transfers to enterprises, and pay into a compen levels arc reduced and the growth of wages is slower sation fund.29 In 1991, it is assumed that the Trust Fund than that of production: by the end of the scenario the makes OM 15 billion in capital transfers to enterpri e� government consumption ratio is assumed to be 3 per for restructuring purposes. with a further DM 15 billion centage points lower relative to GDP than that in west in transfers to banks as guarantees on liquidity loans Germany. due to economies of . ea le in public adminis made in the second half of 1990 arc called. In subsequent tration (for example. in defense and in foreign relations), years. outlays above the line arc solely in the form of which arc assumed to be reflected entirely in the east interest payments; these arc largely covered by dividends German accounts. After 1991. social transfers also drop received, with the result that the deficit drops rapidly .10 sharply as the unemployment rate falls. Government Below the line. as the privatization process gets under investment expenditures arc assumed to rise markedly in way. receipts are directed to reducing the debt of the 1991-92: after 1993 they stay constant in real terms and Trust Fund and making compensation payments. By the thus decline steadily relative to GDP. Over the entire late 1990s, all assets have been privatized. the debt of scenario, net fixed investment of the Government ac the Trust Fund has been redeemed. and substantial counts for one fifth of the economy-wide total, broadly payments have been made to the compensation fund. but in line with the share of the west German capital stock no funds have been applied to reducing the debt of the located in the general government sector. Interest pay general government..11 ments, on the other hand. rise in relation to GDP. Indeed. the rise is much larger if one includes interest payments Scenario B made by the fiscal sector in west Germany related to the financing or transfers to east Germany (see the memo Supply Developments randum item in Table 4). On the revenue !.ide. collection!. of indirect taxes fall This scenario takes the same starting point as scenario notably relative to GDP over the �ccnario as consumption A. However, the development of key supply-side vari grow� more slowly than output. The underlying trend in ables soon sets the path of the economy on a lower the ratio of �ocial security contributions to GDP is also trajectory. Investors are more reluctant to commit them downward as the share of tabor income in national selves than under scenario A.'� and this reluctance is income declines: initially, this is not apparent in actual exacerbated by aggressive wage demand-real wages receipts as collection efficiency rises with the improved grow by 21 percent in 1991 (Table 5). compared with liquidity situation of enterprises. Falling shares of indirect 8 percent in scenario A. These developments are com taxes and social security contributions are only partially pounded by a slower rate of improvement in the efficiency offset by rising direct tax collections relative to GDP. parameters in the economy. At the end of the scenario. the tax ratio is about In contrast to scenario A. output at factor cost declines 3 percentage points lower than in we�t Germany. reflect in 1991. and the relatively large incrca e in tabor ing lower income levels and a higher !.aving ratio. �8 By 200 I. the imbalance in the general government .,, 11 b a;,�umed 1ha1 rc�ourcc' of lhc compcn-.alion fund arc u'cd compc•"mc !hose who suffered financial lo"cs as a rcsuh of 1hc accounts ha� been almost entirely eliminated. Thus. net 10 n:uionalinlion of privalc properly in lhc GDR. saving by the Government covers most of its net invest "' 11 i� assumed 1ha1. afiCr 1991. lr:ll»fcr� In cnlcrprbcs lor ment. llowcver. incorporating also interest payments rcs1ruc1Uring purposes are handled by Ihe M1bs1diary holding companic-. b and do 1101 appear on 1hc ooh uf 1hc Tru'l Fund. " Given lhc many uncenainlie' 'urrnund1ng lhe financial �iiU:uion Germany would. I or example. have a diffcrcnl incidence lhan servicing and pro�pcCis of 1he Trusl Fund and al\o lhc need for compcnsauon I he 1ncrc:"cd dcbl 1hrough cub 1n cxpcndiiUre affcc1 ing all of Germany payrnenh. il is extremely diflicuh 10 :mlicipale cilhcr lhc fintmcial ICl ur lhruugh incrca,cu 13'\ rale,. rc\ourcc' lhal will be available 10 lhC Tn"l Fund nr 1hc cx1cn1 : Thl' \\OUid cnrre,p :• L{>\\er mcomc 1cvcb inlcracling wuh I he progrc,�ive lax ;LruciUre '! Thi' could reflcc1. for example. unrc,ohcd que,lion� ol pmpcny n.:,uh m '' 'mallcr direcl lax ra1io. "h1lc I he higher -.aving rmio reduce� righh. a ;low unwinding of in,liiUIIUnal ng1dilie' lcfl O\Cr from inlli1CCI lax cullcclion' relalive Ill GDP. ccn1ral planning. and a more cauliou' vie" on cxpcc1cd prolil' 87 ©International Monetary Fund. Not for Redistribution V • EAST GERMANY: THE NEW WJRTSCHAFTSWUNDER? Table 5. East Germany: Key Supply-Side Elements of Scenario B Relative to FRG Growth Rates' (FRG = I) 19902 2001 1991-' 1992-94 1995-97 1998-2000 200 1 1991-2001 Net domestic product at factor cost� 009 0.13 -2'12 8'/, 7'12 61/2 6 61/2 Employment' 0.29 0.22 -23 y, -'h - y, -2 Labor force 0.29 0.23 -2'12 -2 -I'/' - 11/2 -I y, - 2 Unemployment rate" 25 21 13'/i 10Yz 9 Adjusted unemployment rate1 36 241/2 13'1.- 10'/z 9 Net emigraiion (in thOltsand,) 100 207 136 108 90 Output per worker 0.31 0.60 26'/, s 61/.- 7 7 9 Net capital stock� 0.09 0.12 4'12 7 7 7 6'12 6'/z 5 35'1! 61/.- Net capital per worker 0.29 0. 7 6'h 7'12 7'/' 9 Grm.s compensation per worker 0.4.1 0.57 21 112 3 6 7 5 General efficiency factor (g) 0.80 0.90 3'12 lfl Y2 •;, Labor-specific efficiency factor (hl 0.67 0.90 6 3 2 2 2 2'/' Source: Author$· calculations. 1 In percent a year: rounded 10 the nearest '12 of I percent except for the unemployment rate. which is the annual average rate for the period specified. in percent of the lab<)r force. and migration. which is the annual average in thousands. ' Second half of the year at :m annual rate. ' Relative to the second half of 1990. with data for the second half of f990 on an annualizcd basis. Sec footnote 23 in the text. • In constant I 990 prices. ' Including tho>e on shon-time work. " In percent of the labor force: includes only full-time unemployed. 1 Adjusted to incorporate the degree to which pan-time workers arc unemployed. productivity is the mirror image of the sharp fall in to rapid wage growth, and disposable income is further employment. In the following few years, wage devel raised by unemployment benefits. Over the remainder of opments respond to market forces and real wages stay the scenario, investment rises at quite a respectable broadly unchanged. encouraging some recovery in in rate, but both its level and growth rate are much lower vestment and stimulating employment but output growth than under scenario A. After its initial surge, private is slower than in scenario A. In the second half of the consumption is restrained by slow growth of disposable scenario, the economy settles into a pattern of steady income. Government consumption also rises more expansion at 6-7 percent a year. With the labor force slowly than in scenario A after 1991, reflecting, inter declining more rapidly than in scenario A, owing prin alia, lower wage growth and the declining population. cipally to increased westward migration, the unemploy Overthe entire scenario, the reduction in output relative ment rate falls for a number of years but then levels out to scenario A is only partially compensated by lower at a rate of about 9 percent toward the end of the scenario. demand, with the result that the external imbalance on The high unemployment is a reflection of structural goods and nonfactor services declines more slowly and rigidities that are assumed to become ingrained in the still represents I 0 percent of GDP by the end of the economy. These rigidities are also apparent in the path simulation period. From a saving-investment perspective, of the efficiency factors, which by 200 I are still consid the weaker external position refiects a smaller national erably below levels in west Germany. saving rate under scenario B: this is partially offset by a decline in the investment ratio. The drop in saving is Demand Developments mirrored in the higher government deficit. Demand rises more slowly in 1991 than under scenario Fiscal Developments A. but, with output growth also weaker, the external deficit on goods and services is not much lower (Table Because of less buoyant economic conditions. the 6). investment expenditure falls, but this decline is to a fiscal situation in scenario B is considerably weaker than large extent offset by a faster rate of expansion of private that under scenario A (Table 7). The rise in the deficit consumption. Despite the higher unemployment, labor in 1991 reflects a higher expenditure ratio as government income grows more quickly than in scenario A, owing consumption and investment absorb larger shares of 88 ©International Monetary Fund. Not for Redistribution Scenario B Table 6. East Germany: Demand Pattern Under Scenario B (Period averages) 19901 19912 1992-94 1995-97 1998-2000 2001 (In billions of (Percelll change a year) de11tsche mark) GDPJ 216 8'1: 7 6'1! 6 Domestic demand 332 2 3'12 3'12 3'/, 3'12 Private consumption 180 6 l'h 3 3 3 Government consumption 78 -6 3 2'12 2 I 'I: Gross fixed investment 73 - '12 8 6 5'1z 5'12 Household disposable income 190 5'11 1 '12 3 4 4'12 (Saving rote) 5 4'12 41/z 5'12 7 9 (In billions of 1990 deutsche mark) Foreign balance on goods and nonfactor services -116 -122 -103 -81 -59 -43 (In percem of ea.�t German COP) -54 -56 -41 -25 -16 -10 Current account• -23 -29 -37 -38 -38 -34 (In percem of east German COP) -11 - 13 - 14 -12 -10 -8 Gros� national saving' -44 -49 -20 14 47 73 (In percelll of east German COP) -20 -23 -8 4 12 17 Gross investment 74 74 88 106 125 139 (In percem of east German GOP) 34 34 34 33 32 32 Fiscal transfers from west Gennany 95 94 71 53 41 33 (In percent of east German GOP) 44 44 28 17 11 8 Net external liabilities• 32 62 133 249 363 433 (In percent of ea.w German GOP) 15 28 51 77 94 100 Memorandum item.r (in perce/11 of east German COP): Current account (Excluding fiscal transfers) -ss -57 -42 -29 -20 -IS Sectoral financial balances Households 4 4 4 4 5 6 Enterprises1 -9 -8 -9 -8 -8 -8 Government -so -53 -37 - 24 -17 -13 Source: Authors' calculations. ' Second half of 1990 on an annuali7.ed basis. ' Percent changes are rclmivc to the second half of 1990, with the second half of 1990 expressed on an annualizcd basis. Sec footnote 23 in the text. ' Differences between GDP growth and the growth of net domestic product in Table 5 reflect principally the influence of the changing share of net indirect taxes in GDP. " Including balances on transfers and investment income. The balance on investment income includes all property income (net of tax) attributable to nonresidents. including re tained earnings of enterprises owned by nonresidents. ' Excludes fiscal transfer� from west Gennany. " End of year. or average of end-of-year data for groups of years; represents the initial debt level plus the cumulation of the external current account deficit. 7 All investment income attributable to nonresidents is treated as an outlay. including retained earnings of enterprises owned by nonresidents. national output and social transfers are boosted by the greater under scenario 8, owing to the larger unemploy increased unemployment rate. Surprisingly, the ratio of ment and the higher dependency ratio in the economy. 33 revenue to GDP is also greater in scenario 8 as collec Capital expenditure, on the other hand, is only slightly tions, relative to GDP, of indirect taxes and social higher relative to GDP than in scenario A as real outlays security are raised, respectively, by the surge in con are lower. Over the entire scenario, however, government sumption expenditure already noted and the higher share net fixed investment represents one fourth of total net of labor income in national income. In subsequent years, fixed investment, a higher share than under scenario A the deficit declines, albeit at a more gradual rate than in (one fifth). interest payments rise relative to GDP scenario A. As in scenario A, most movement occurs in throughout the scenario; the increase is particularly fast the expenditure ratio. While government consumption if one takes into account interest payments reflected in grows more slowly in this scenario, it is not sufficient the west German fiscal accounts. to compensate for weaker output growth, and thus by The financial position of the Trust Fund is also weaker the end of the simulation period, the ratio of government under this scenario. The principal difference is below consumption to GDP is considerably above that in scenario A. The burden of social transfers also remains 33 Migrants are disproponion:uely from the working-age groups. 89 ©International Monetary Fund. Not for Redistribution V • EAST GERMANY: THE EW WIRTSCI-IA FTSWUNDER? Table 7. East Germany: Government Finances Under Scenario B (In pcrcenl of GDP in cast Genn�ny, period averages) 1990' 1991 1992-94 1995-97 1998-2000 2001 General govcmmcnl balance' - 50 - 53 - 37 - 24 - 1 7 - 13 Revenue 39 44 44 41 41 41 Tax revenue 39 43 41 39 38 38 I ncomc and corporate !axes 3 4 5 7 X 9 Social <;ccurity !axes 16 19 19 17 16 16 Indirect taxc� 19 20 17 15 14 13 Nontax revenue I 2 3 3 3 Expenditure 90 97 XI 66 ss 54 Current expenditure 83 87 71 57 SI 47 Consumption 36 34 30 26 23 21 Social transfers 35 41 31 22 19 18 Unemploymenl 13 19 10 5 3 3 Pensions 11 13 13 11 10 10 Other 10 10 8 7 6 5 Interest 2 2 J 4 5 5 Other 9 9 6 4 4 4 Capital expenditure 7 10 10 9 7 7 Fixed investment 5 7 7 7 6 5 Transfer� 2 4 3 2 2 2 Trust Fund balance -9 - 14 - 2 -I - 1 - 1 Fbcal tran�fcr.. from west Germany 44 44 28 17 11 8 General government debt' 26 35 -19 67 79 ss Tmst Fund debt' 9 40 24 13 '-) 9 Memorandum items: Total interest. including imcrcst in west German liscal accounts1 2 4 11 17 20 21 Ci encral government balance. including interest in wcsl German lbcal accounb -50 -55 - 45 -37 - 32 -29 General government debt. including debt regi�tercd in wc>t Gcnnan fiscal account�'-' 48 101 167 232 271 287 Source: Authu�· calculation�. 1 Second half of the year on an annualized ba�is. � National account� ba�is: excluding fiscal transfers from west Germany. ' End of year. ur average of end-of-year data for groups of years. ·• Interest in the west German accounts related to financing fiscal transfers to east Germany. ' Debt incurred in the west German accounts related to financing fiscal transfers to cast Germany and the associated interest payments. The debt level at the end of 1990 refccts the initial debt level assumed for July I. 1990 and the borrowing requirement in the second half of 1990 (i.e.. at half of the annual rate implicit in the column for 1990). the line. however. The less buoyant economy results in Supply Issues lower receipts from privatization for the Trust Fund.�4 Thus, when privatization has been completed, and as Investment plays a key role in the supply side not suming the same payments to the compensation fund as only by providing additional capital services but also as under scenario A. a significant debtremains on the books an important vehicle for technical change. The capital of the Trust Fund. needs to bring productivity levels in east Germany close to those in west Germany over the next decade are Issues Arising from the Scenarios clearly enormous. The belief that capital will be quickly forthcoming is based on a presumption that the potential The illustrative scenarios presented in the previous rate of return in the east is much higher than in the west. two sections demonstrate, at the very least. the degree However, there are a number or factors that might create of uncertainty that surrounds developments in east Ger uncertainties about the prospective rate or return and many over the next decade. The two scenarios, thus, generate a weaker response from investors such as provide a userul background for discussing a range of illustrated in scenario B. It is important, for example, issues related to GEMSU. lhat the legal and institutional structure be supportive. Three key questions arise here: Will the issue of property '·' In addition. it is <�ssumcd that the Trust Fund takes on an extra rights, related, for example. to past nationalizations, be DM 10 billion in debts owed by companies that arc liquidated_ resolved quickly enough to give investors confidence 90 ©International Monetary Fund. Not for Redistribution Issues Arising from the Scenarios that legal complications will not arise? How will the higher employment and lower wage growth? Clearly, costs of the environmental cleanup be allocated? And this trade-off exists in principle, but in the short run, the how promptly will the new administrative structure in coexistence of rapid wage growth with high unemploy the east be able to make the change from a planning ment would not be particularly surprising. First, rapid system to one more oriented to market requirements?35 wage growth is a means of breaking free of the compres Then there is the question about the adequacy of the sion of the wage range that has characterized the former economic infrastructure; this issue arises not only because GDR and seems particularly likely for highly skilled provision of complementary public services is important workers for whom the option of migration to the west is for enterprise efficiency but also because it affects the greatest. Meanwhile, the social safety net will limit absorptive capacity of the east. Absorptive capacity is downward pressure on the wages of those who have been of course a wider concern; one can imagine machinery relatively overpaidY Second, unemployment rates te11 and equipment being largely imported and construction little about the match of skills of the unemployed to the activities being able to draw on a large pool of unem emerging work opportunities; this may well be an im ployed workers. But bottlenecks could emerge in areas portant issue in the initial years of the transition. when such as the transportation of investment goods or the some ski11s are likely to be in particularly !'ihor1 supply availability of specialized construction skills. Investors and others in large surplus. Moreover, offering labor are also likely to be sensitive to the stance that unions services at reduced wages in an area in which effective take in wage bargaining; large wage demands may scare demand is not perceived as being readily forthcoming off investors. More generally. there are important gaps may not be a strong encouragement to employers to in our knowledge of the reasons why some underdevel boost employment or for unions to be more moderate in oped regions attract capital and grow quickly while others their wage demands.3g Fina11y, linkages between tabor get relegated to the economic periphery. In this context, markets in east and west Germany can be expected to tradition may favor east Germany: before World War l1, develop quickly, especially in areas close to the former industry in the southern part of east Germany, in partic border between the GDR and the FRG and in the market ular, was strong. This suggests that, if the other factors for skilled Jabor. w This said. the response of wage growth mentioned above are, on balance, favorable, there are to market conditions does play an important role in the good prospects for the cast's economy. scenarios. In both scenarios, the initial large labor share Scenarios A and B. as well as the calculations in is unwound as wages grow more slowly than productivity Chapter IV, illustrate the importru1ce of assumptions on for a number of yeru·s. Moreover. in scenario B, in the degree of inefficiency in the economy and the speed with which this can be removed. These inefficiencies affect the rate of return and hence the level of investment. with high unemployment in the FRG in the 1950s, when a less developed social safety net than assumed for ea�t Gern1any in these Moreover. eliminating inefficiencies is likely to be the scenarios would have been expected to strengthen the negative most important source of supply response in the first relationship between unemployment and wage gro wth (sec Box I). year or two of the economic integration process. lt is " Most workers in cast Germany arc likely to be eligible for compensation. on average. at 67 percent of the last net wage. In west difficult, however, to get a sense of the scale of these Germany. only one half of the unemployed receive full benefit�. inefficiencies or the speed with which they could be 's Where domestic production is � good substitute for impons or eliminated. For example. if substantial migration of wheer cxpon markets have been developed. the increased output might be absorbed through changes in the foreign balance: relative prices highly skilled workers to west Germany continues. what could. in principle. move to encourage the appropriate shift in demand. would be the implications for the potential productivity with the relative price shift needed not being panicularly large in a of workers remaining in the east? The nature of ineffi small economy well integrated in the world economy. However. in the environment such as that likely to exi>t in ea�t Germany in the ciencies is also quite important. The existence of general first year of GEMSU. with large changes in the composition of factor inefficiency is more favorable to the size of the demand and supply. major institutional developments. and substantial initial supply response. In the case of .labordishoarding. ma rket disequilibria, questions arise 91 ©International Monetary Fund. Not for Redistribution V • EAST GERMANY: THE NEW WIRTSCHAFTSWUNDER? response to the particularly large jump in unemployment second half of 1990 is worse than was. perhaps opti in 1991. wages stagnate for a few years. mistically, projected. That the budget has deviated from projections is not. however, particularly surprising: the Demand Issues scenarios illustrated the uncertainties about the fiscal situation and how vulnerable it is to weakening in � Developments on the demand side are likely to play economic conditions. an important role in influencing initial supply conditions. On the revenue side, apart from concerns about the While a large increase in demand in east Germany is to vulnerability of revenue collections to less favorable be expected. it is not clear to what extent this will fall economic developments. questions arise as to the extent on domestic products. Investment in machinery and of administrative difficulties in levying taxes in the early equipment and consumption spending, for example, are stages of GEMSU. There are also issues related to both likely to have a large import content. This pattern uncertainties about the prospective size of receipts from or demand may pose a problem for realizing the potential privatization and the financial position of the Trust Fund. response or supply tO improved efficiency in the initial On the expenditure side, the finances of social ex stages of GEMSU. when the options of boosting exports penditure programs arc vulnerable to adverse develop ments in the economy. Moreover the fiscal burden that or displacing imports may well be perceived as limited. . Of the various components or demand, output is likely might arise from providing west German standards of to be most responsive to increases in construction de health care in the east is not yet fully apparent. Uncertainty mand. underlining the impot1ancc of a fa vorable invest also surrounds the needed scale and the timing of public ment climate for short-term output developments as well infrastrucrural expenditure.42 Perhaps even more impor as for the long-term supply response. Over the medium tant, however, than the total investment needs of the to long tern1 , however. marketing goods should be less Government is the scale of govcrnmenr investment in of a problem as new investment comes on line producing the initial years of GEMSU: this will be important, both goods oriented to a market environment. and a prominent for encouraging private investment and limiting social role of fo reign investors could further ease placement of (and migration) problems associated with high unem goods in external markets. ployment. A further unknown is the initial level and A second uncertainty on the demand side revolves growth path of government consumption: important con around consumption behavior. Initially. a key question siderations here arc the level of government employment is the degree or financial dissaving that can be expected that existed in the former GDR. the scope for its reduction and the extent to which such behavior has already and for improving efficiency in other areas of government occurred. given the greater availability of consumer goods consumption. and the economies of scale in public since the opening of the border between east and west expenditure that might come from the process of eco Germany. Moreover, the general uncertainty and high nomic integration. Finally, the scenarios and scenario B unemployment may initially engender more cautious in part icular, highlight tensions that are likely to give consumption behavior on the part of those who remain rise to pressures for subsidies to support employment and wages. in their jobs. Nevertheless, household saving is likely to One of the more controversial issues facing fiscal be low for a number of years . reflecting pent-up demand for consumer goods and the large share of income support policy is how deficits resulting from fiscal operations in payments in disposable income. In scenario A, with east Germany should be financed. As mentioned above, rapid growth in household incomes, the household saving these deficits are already looming much larger than had rate subsequently rises quickly toward the level in west been projected earlier by the authorities. The consider Germany. In scenario B. lower income levels and higher ations bearing on the question of financing were outlined . .. unemployment restrain the rise in the saving ra te.�0 in Chapter I (section on .The Stance of Policies ). There, the degree to which higher deficits would be a temporary phenomenon was judged a key element. A Fiscal Issues"' comparison of Tables 4 and 7 underlines the extent to which this will depend on the success in revitalizing the The government finances are likely to be used as a economy of east Gcrmany.4J barometer for developments in the overall economy. Already in the early months of GEMSU, there has been 42 In west Gennany. about 20 percent of the net capital stock is in concern about reports that the fiscal situation in the the hands of the genen1l government and in �cenario A about 20 percent of the cumulative net inve�tmcnt i� as�umed to be carried out by the ge neral government. This doe� not include capital transfers to 40 Data on household �aving bchavior in the FRG in the 1950s can p�blic bodies outside general government (e.g .. the post office or the be found in 8011 I . nulways). "' Fiscal issues related tu GEMSU arc discussed also in Chapters 4' The implications of thc�c scenarios for the fiscal accounts of all I. VI. XI. and XII. of Gennany can be seen in Table 4 of Chapter VI. 92 ©International Monetary Fund. Not for Redistribution