GERMANY-ECONOMICS

CONTEXT
The serene revolution in East Germany in 1989 was the starting point for Germanys political
and economic reunification. On November 9,1989 the Berlin Wall collapsed. The following
relocation from East to West and the growing expectations of those who stayed in East
Germany made a gradual economic reunification almost impossible. The roadmap was
dictated by the fear of an economic breakdown and political instabilities. When the situation
became unstable in early 1990 a swift economic, monetary and social union was agreed on
which made the reunification irreversible1. On July 1,1990 the Deutschmark was introduced
as the sole legal tender and the West German economic order has come into effect. As a
symbol of West Germanys social market economy, democracy and wealth the Deutschmark
was supposed to become the symbol of reunification2. The political reunification followed on
October 3rd 1990.
The starting point of the previous cycle in Germany was the 1995 recession, when export
growth was choked off as a result of a sharp increase in German wages and the Mexican peso
crisis, which was accompanied by a significant appreciation of the DEM. The end point is
marked by the slowdown in 1997/8. Again an external shock set off the end of the period; this
time it was the Asian crisis. The 1995/98 cycle appears to be highly typical for the German
situation in the 1990s, as both its beginning and its end are triggered by external events, with
domestic policies, notably in the labour market, contributing their share to aggravating the
situation.
To better understand the context we study Germany as three business cycles (1992/3, 1995/6
and 1998). Insert Graph
2001 clearly marks the end of what is already the third full business cycle after German reunification. With troughs in 1992/3, 1995/6 and 1998, the average length of a business cycle
in the 1990s is a mere three years long. This distinguishes the German growth pattern clearly
from the business cycle in the USA, which lasted longer than the full three German cycles
combined. The German cycle is also substantially shorter that those of most other European
countries, with the exception of Italy, the other European country that shows particularly

1
2

(Sinn/Sinn, 1991, 11; Giersch/Paqu/ Schmieding, 1992, 261)

(Weimer, 1998, 367).

weak growth in recent years. France, for instance, basically skipped the 1998 recession
experiencing only a mild slowdown in growth. This means that in France the time from 1995
until 2001 forms part of a single cycle. Before 1998, growth in Germany, France and Italy
went in parallel. Since then, France set itself apart form the two other countries. The pattern
of 1998 might repeat itself in the present downturn: Germany already practically stopped
growing since the third quarter of 2000. Quarterly growth in the six months from the third
quarter of 2000 until the forth quarter of 2001 averages 0.05%. By contrast, average quarterly
growth in France during this period, even though also levelling off recently, remained at
0.4%. It is therefore of particular interest to analyse the present and previous cycles.
ECONOMIC INDICATORS
GDP
After the re-unification boom of the early 1990s with GDP growth rates of 5.7 and 5.1 per
cent in 1990 and 1991 respectively, Germany has had a weak growth performance with a
relatively low growth rate of GDP of around 1.5% in the period 1995 - 2003. Since 1994, the
German growth rate has been lower than the EU average in each year, and since 1998
Germany and Italy are the tail-light of the European Union in terms of growth.
Consumption
A disaggregation of domestic demand into its components reveals that the problem of weak
demand is not so much found in equipment investment, which grew over the same period by
about 6% annually. Rather, private consumption remained very slack throughout the period.
It only grew at an annual rate of 1.2% over the two-year period. More importantly, most of
that impact only came in the last two quarters of the cyclenot enough to lift Germany onto
a sustainable growth path. The underlying reason is that, during the period under
consideration, real disposable income barely rose by 1%. One important aspect is that despite
rising wages, a rise in the wage sum was held back by a reduction in employment by 0.5%
during the cycle, because the growth rate during 1996/7 was not enough to generate
employment growth. This situation was aggravated by a rising tax burden.
The recovery after the 1998 downturn in Germany shows some of the features of the previous
recovery (Figure 1.2c). In particular, it is also very short-lived. The period with high growth
lasted no longer than from the first quarter of 1999 until the second quarter of 2000, and even
here a brief spell of negative growth is interspersed (in the second quarter of 1999). However,

the role of trade is not quite as prominent as in the previous upswing. The initial spark instead
is provided by the 1999 tax reduction and transfer package of the incoming government,
which led consumption to increase by 2% in one quarter. At the same time investment rose
rapidly. A backlash in these factors in the second quarter of 1999 is partly compensated by a
rising external contribution. Throughout the cycle, equipment investment plays an important
role in sustaining growth. Also, and in contrast to the previous cycle, private consumption
growth is gathering momentum in the period between 1999Q3 and 2000 Q4. It all but
appeared that Germany finally reached the stage of sustainable growth. Growth was both
higher than in the previous recovery and most importantly it was internally generated.
The rapidity of the break in German growth is, however, mainly explained by the high loss of
purchasing power, which set in as a result of the fall in the Euro exchange rate and the rising
oil prices. How substantial this loss in real disposable income is can be seen when the GDP
growth for 2000 of 3% is compared with a terms-of-trade adjusted real value of GDP growth
of only 1.5%. Most of this terms of trade loss is concentrated in the final half of the year
leading real disposable income growth and with it consumption to stagnate. In addition, in the
first quarter of 2001, equipment investment and construction activity shrank substantially.
Only a rise in the external contribution kept Germany from negative growth during the first
half of the year. The impact of the US slowdown provided the final straw that kept the
downswing from being only temporary. Even though the impact was not felt much on the
export side before the end of 2001, the transfer of declining confidence via the stock market
appeared to have a more immediate impact. The events in the context of the terrorist attacks
in the US have contributed to a deepening of the recession, but cannot be considered the root
of the 2001 recession.
Exports
German economy, despite its large size had a strong dependency on external developments.
As shown by Figure 1.6, the degree to which export expansion and GDP growth move in
parallel is indeed remarkable. All turning points in the growth cycle trace contemporaneous
changes in the rate of exports. A positive correlation of exports to GDP is certainly no
surprise, because exports are included in the calculation of GDP itself. However, the
contribution of net exports to growth is relatively small and less correlated with growth than
exports alone. Insofar as other EU economies, and hence German exports, are subject to
similar monetary policy shocks as Germany via EMS and EMU, it is remarkable that in

Germany the correlation between exports and GDP growth is stronger than what can be
observed, for instance, in France and the UK. It is especially weak in the cases of Italy and
Spain. Insert figure 1.6
An analysis of the short-term economic situation identifies external factors as the outstanding
features in generating business upturns and downturns in Germany. At first glance this is
astonishing, given the size of the economy. It appears, however, that a significant part of the
attention to the external side in Germany is given by the fact that since 1991 average
quarterly growth in Germany amounted to a pale 0.4%. With such a low underlying growth
rate, fluctuations in the external contribution can easily turn a mildly positive growth rate into
a negative one and thus make the difference between a boom and a recession. While it
appears that Germany also had a streak of bad luck in the timing of the external shocks,
clearly the fundamental problem is that the country does not succeed in generating a
sustainable domestically-driven growth path. Consequently, it is not able to take full
advantage of the impulse of an export boom. Apparently, France succeeded much better in
this respect in past years, allowing the country to ride out negative external shocks without
losing much economic momentum.
Unemployment
1 million jobs were lost between 1991-2000 in manufacturing sector alone.

This

unemployment effect cannot be attributed solely because of shutting down of old companies,
but also because Germany failed to attract sufficient new investment. A region trying to catch
up in terms of income, productivity and employment should have low unit labour costs than
other regions in order to compete for more investment and jobs. High and only gradually
dropping relative unit labour costs took a severe levy in the labour market. In 2000, there
were on average 1.36 million unemployed people in East Germany.
The specific behaviour of job-growth is mirrored by the development of unemployment. In
particular, Europe saw a sharp increase in their unemployment rates during the business cycle
downturns, which was not reversed symmetrically during upturns (see Figure 1.8 above).
This supposed hysteresis phenomenon of unemployment in continental Europe stands in
stark contrast with developments in the US and the UK where labour dismissals built up
during economic downturns were quickly absorbed during the upswings. Again, for France
and Italy the situation appears to have improved since the mid-1990, with the unemployment
rate at the end of the period in these countries roughly at the level observed at the beginning.

Apparently no such improvement occurred in Germany, where unemployment at the end of

the period was almost twice as high as that at the beginning.
Weakness in domestic demand has been the principal factor explaining the growth gap
between Germany and its European partners since the mid-1990s. In particular, private
consumption has been dragged down by sluggish growth of households disposable income
as employment growth was anaemic and the purchasing power of households was dented by
an increasing tax burden. Construction is the other factor behind the growth gap. The
performance of the construction sector in the second half of the 1990s was severely affected
by the onset of saturation effects in the New Lnder, the phasing out of generous public
subsidies for construction investment, especially in the New Lnder, and a slow rate
population growth.
As serious as the consequences of the ailing construction sector in Germany on output and
employment growth may be, in some sense they appear inevitable. By contrast weak
employment growth, which has in the more recent past constituted a serious obstacle to a
more pronounced rise in economic welfare, is an area, which needs to be tackled through
economic reforms.
Public Debt and Deficit
Public debt was 57% of GDP in 1995 rising slowing every year. One of the reasons was that
the eastern German economy still depended upon resource transfers from western Germany
for 45% of its total expenditures
According to Pasinetti's definition (1998a, b; 2000), public finances are sustainable as long as
the public debt grows at a rate equal to or smaller than the nominal GDP growth rate. A
stable debt ratio implies a stable tax burden on taxpayers due to the level of the public debt.
Applying Pasinetti's sustainability concept to Germany's public finance position over the
period from 1988 to 2000 shows significant positive gaps in the period to 1992, followed by a
period of protracted negative gaps until 1998 (Figure 1). The difficulty of unsustainable
public finances ascended only with the sharp recession of 1992-93, and subsided with the
long-delayed recovery of 1997-98. Therefore, it is clear that re-unification per se did not pose
any immediate risk.
Productivity

Productivity has been one of the main factors dragging down the growth of GDP. This was
because the rise of wages in East Germany accelerated faster than rise in productivity. Wage
convergence in collective agreements had the consequence of high unit labour costs caused
by wages that have been about 13% above productivity on average since 1996 (Figure B1.3).
In 2000, remuneration per employee was at 78% of the West German level, although output
per employee was at 71% of that in the West even though an average weekly working time of
38.9 hours in 1999, compared to 36.8 hours in West Germany. Amid the reasons for the low
labour productivity in the new Lnder are a low capital intensity due to different relative
factor prices, a low utilisation rate of production capacities and the need for many East
German firms to compete through lower prices. Wage developments in East Germany are a
consequence of many forces, preventing wages from developing in line with productivity.
Labour productivity rate in late 1990s continues around 2%, higher than its neighbouring
countries.
Objectives
In 1997, the economic production was under 57% of that of the west, and the wage costs in
connection with real net output were nearly 30% higher. Hence, their most important
objective was to increase productivity in order to reduce the impact of the high labour costs,
and the way they tried to achieve this was by maintaining existing jobs and creating new ones,
in cooperation with business management.
For the development of East Germany, the business sector and all the trade and industrial
associations have pledged to apply measures to stabilize capital expenditure on equipment,
but they made this guarantee on three conditions:
a. The trade tax be abolished
b. Investment and equity assistance remain available to trade and industry
c. Overall investment-friendly conditions exist
Federal Government contributed to the this development by providing tax incentives,
eliminate special depreciation allowances in return for a noticeable increase in investment
allowances, provide assistance in the housing construction industry for the modernization of
old buildings, and provide a six year plan and conditions for assistance.

With the data available it shows that both the German government and the German people
did everything they could to make this unification work. And it has, in fact, worked thus far,
which can be supported with the latest data. Germany now is the fourth largest economy in
the world, with a GDP of $3.747 trillion in 2014, and a per capita GDP of $45925, which also
makes Germany the largest economy in Europe. Other data that show a marvellous
improvement in Germany include unemployment of 6.7%, and inflation of 1.4%. In
conclusion, all these indicators show that Germany came a long way since the fall of the
Berlin Wall, particularly due to the negative economic and political conditions of East
Germany.