East Germany, West Germany, and Their Mezzogiorno Problem: A Parable for European Economic Integration

Economic and monetary reunification in Germany has proved to be more expensive than previously thought--and not jus t for the Germans. If a "Mezzogiorno problem" of continuing fiscal transfers to the East, and possible migration flows westwards, are t o be avoided, then there has to be convergence in productivity levels. This paper analyzes possible convergence paths, and the policy regim es which accelerate convergence. The intention is to illustrate the (albeit less extreme) problems facing a European monetary union of asymmetric and incompletely converged economies. Working from first principles, or with the aid of an econometric model, shows that convergence sufficient to avoid a Mezzogiorno problem is likely to b e slow: perhaps 30-40 years in the German case, despite very fast grow th in the East. Second, it is not clear that the process is incentive compatible: a very substantial part of the servicing and subsidizing costs have to be paid by other (non-German) economies in the union, without any obvious compensating benefits. Third, to reduce the need for continuing transfers actually requires a policy which promotes price and wage flexibility in the depressed region. That appears to run counter to the current market integration within Europe. Such "unpleasant arithmetic" is an important contribution to the monetary union debate because without it, the smooth running of a union of incompletely converged economies will certainly be compromised. Copyright 1993 by Royal Economic Society.