Lessons from the 25th anniversary of Germany’s own rocky fiscal unification

Memories of the GDR.
Memories of the GDR.
Image: Reuters/Pawel Kopczynski
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The year after the Berlin Wall fell, East Germans got “shock therapy” in the form of abrupt capitalism after 40 years of a state-controlled economy. Twenty-five years ago today, East Germans adopted the West’s Deutschmark as the fiscal stage of the country’s reunification began, and the effects are still felt today. As Greece grapples with possible default and an exit from the euro zone, it’s the perfect time to remember the lessons from the Deutschmark.

When the idea of fiscal unification first started floating around in early 1990, a popular chant arose in East Germany: “Kommt die D-Mark, bleiben wir, kommt sie nicht, geh’n wir zu ihr!” (If the Deutschmark comes, we’ll stay here; if it doesn’t, we’ll go to her). The public demanded a one-to-one exchange, and on July 1, 1990, the banks in the former GDR opened to lines people waiting to get their hands on Deutschmarks at the unbelievable exchange rate of 1:1. (Up to a certain level: Rents, scholarships and salaries were converted at a rate of 1:1; debts were converted 2:1.)

The economic reunification gave the 17 million East German citizens the chance to own property, to experience a free marketplace for the first time and to get their hands on coveted West German products (German), the Stuttgarter Zeitung writes.

About 25 billion Deutschmarks were shipped to the East for the fiscal reunification; 3.4 billion were distributed on the first day alone, leading to a spending spree the likes of which the GDR had never seen. The GDR’s state-set prices didn’t translate to the rest of the world. Frank Stocker writes of the state-controlled prices (German) in the Welt am Sonntag: “A bread roll for 5 pennies, 25 [Deutschmarks] rent for a 40 square meter (430 square feet) apartment, 1,000 [Deutschmarks] for a Sony Walkman.” Even if you had the money, the 10-year waiting list for a Trabant car was immutable.

The fiscal reunification cost Germany’s social system about 1.5 billion euro, writes Philipp Ther in the Süddeutsche Zeitung. “It was an extension of West Germany (German), not a union of two equal states,” he writes, pointing out that the law cited in the reunification led to the accession of five Bundesländer.

In the winter of 1989-90, the practical East-West exchange rate dropped to a low of 7:1, but the GDR stuck to its official line of parity between the two currencies, a total fiction. Opening up the border further devalued already low wages in the East, to the point where filling up a gas tank could take a family’s whole budget.

Considering the devaluation of East Germany’s prior currency—the Ost-Mark—how could the two countries set a 1:1 exchange rate? The West’s Bundesbank argued for a 2:1 exchange rate; the GDR Staatsbank wanted a 7:1 rate that more accurately reflected the Ost-Mark’s purchasing power and would’ve allowed the East’s industry to compete with the West’s. But the decision was political: There was an impending national election to consider, and a quick fiscal reunification could prevent a mass exodus from the East to the West.

The radical privatization and rapid introduction of foreign trade constituted a deadly one-two punch to the East German economy. By the mid-’90s, East German industrial production had fallen 27 percent from 1988 levels, Ther writes. Thousands of enterprises went bankrupt, and in many regions unemployment rose to more than 30 percent.

In the four years after reunification, 1.4 million East Germans left their homes, negating the common assumption that a fast fiscal reunification would prevent a mass exodus from the GDR. The crash of the East German economy overwhelmed the federal budget and taxed the already overloaded social system. A sharp increase in social inequality was the price of reunification, along with an economic gap between old and new German states that has still not evened out.

The Eastern restrictions on ownership and investment left a lasting impression, according to researcher Markus M. Grabka. Households in eastern Germany now have an average net worth of 67,400 euros, less than half of western German households’ average net worth of 153,200 euros. Almost half of properties in the West are owner-occupied versus only one-third in the former East. (Though pensioners have it good in former Eastern states: Both men and women usually worked, unlike in the West, and state retirement payments quadrupled (German) in the decade after reunification, Die Zeit reports.)

While Germany’s economic strength today makes seem like the winner of the euro experiment, fiscal reunification wasn’t an easy ride. “If we had to do it again, what could we do better? (German)” Die Zeit asked at the 20th anniversary.

Mark Schieritz, Die Zeit’s finance correspondent, has a clear answer: Set the exchange rate at 4.5:1. “The East Germans had to learn what Greeks and Spaniards now are realizing: A strong currency is not just fun—especially not when it coincides with a weak economy,” he writes (German). Making the exchange rate 1:1 essentially raised companies’ wage costs by a factor of five, making it impossible to survive against Western competitors. With an exchange rate of 4.5:1, or even 7:1, East Germany could have become the China of Europe.

July 1, 1990 wasn’t only an important day for the German reunification, Deutsche Bundesbank President Jens Weidmann writes in Der Tagesspiegel. The first step towards activating the European Economic and Monetary Union happened that day (German), leading to adoption of the euro.

Like Germany after fiscal reunification, some European countries are having competitiveness problems. But that is an argument for further measures to protect the currency’s stability, writes Weidmann, quoting former Finance Minister Karl Schiller: “Stable currency may not be everything, but without it, everything else is nothing.”