Integrating the Eastern Länder: How long a transition?

In the 1990s, the economic policy situation in Germany will be determined by how quickly eastern Germany catches up. This will determine the extent of transfers and, consequently, Germany's fiscal policy stance, which, in turn, will influence the macroeconomic policy mix and the growth potential in western Germany. Adjustment in eastern Germany is making progress. Privatization of the enterprise sector has nearly been completed. In the privatized firms, a restructuring process is under way, thus laying the foundations for future competitiveness. The producing sector has come close to the production level of the second half of 1990. In the nontradables sector, the adjustment process is proceeding smoothly. In the tradables sector, i.e., in industry, things do not look so bright. An export basis has not yet been established. Self-sustaining growth with sufficient momentum and independent of public transfers has not yet taken place. However, investment is developing positively. The investment ratio is more than 50 percent of GDP. More than 80 percent of investment has taken place in the enterprise sector (including telecommunications, railroads, and housing); government investment is not playing the major role. GDP per capita in eastern Germany rose from 28.8 percent of the western German level in 1991 to 40.7 percent in 1993. How quickly the adjustment process will come about will depend on investment, because capital accumulation must be the engine of the catching up process. A simple formula tells us which growth differentials and how much time will be needed if eastern Germany is to reach the level of certain regions in western Germany. Assuming annual eastern German growth is 5 percent higher than western German growth, it will take eastern Germany until the year 2007 to reach an 80 percent adjustment target. Assuming a growth differential of 10 percent, this will take until the year 2000. Reunification has changed the characteristics of Germany as a whole. With an increase in the share of government in GDP from 45 to 52 percent Germany has become a little less of a market economy and a little more of a state economy. The economic system has become less efficient, and this dampens the potential growth rate of western Germany. In this situation, it is of paramount importance to reduce the budget deficit. This task will be easier if eastern Germany proceeds to catch up quickly, because, then, Germany will simply "grow" out of its fiscal policy dilemma.