East Germany Economy: What Lay Behind the Wall

A planned economy that lived beyond its means

The German Democratic Republic ran an economy planned from the centre and organised in large combines, or Kombinate. Its labour force was about 8.96 million in 1987, and 37.5 percent of workers were in industry.³ The Central Intelligence Agency's 1990 Factbook put gross national product at $159.5 billion, or $9,679 per head, and counted real growth of 1.2 percent in 1989.³

Estimates of the economy's size and productivity differ widely. Charles Maier, writing for UNU-WIDER, notes that estimates of the GDR economy run from the implausibly high official statistics to pessimistic values.⁴ He cites value added per manufacturing worker in 1987 of 30.5 percent of the West German level and 21.4 percent of the United States level.⁴ Estimates cited in the DIW's bulletins of the productivity gap are wider still: West German government estimates of about one third, publications rating it from 25 to 50 percent, and a range of 14 to 35 percent in a 1999 study.⁵⁶

Official claims were very different. On 7 October 1989, at the 40th anniversary, leader Erich Honecker said the country had developed an economy with a modern structure and great economic potential, and that its productivity was among the ten highest of the industrial nations.⁵

an economy with a modern structure and great economic potential

— Erich Honecker, 7 October 1989, as quoted in DIW Economic Bulletin 27/2015

Debt, consumption and the cost of earning hard currency

Karl Brenke of the DIW Berlin describes a country that had lived far beyond its means. A growing share of resources went to consumption and too little to the investment needed to renew plant, which he calls a social policy of capital erosion.⁵ Hans-Hermann Hertle, whose article reproduces the Politburo papers, puts the same policy in the party's own words: the unity of economic and social policy. The investment quota was lowered, capacity was cut and infrastructure decayed, while imports of consumer and investment goods from the West were financed by credit.²

The debt was known inside the leadership. On 16 May 1989 Gerhard Schurer, the head of the State Planning Commission, told a small circle of party leaders that the GDR's debt to the West was increasing by 500 million Valutamark a month, and that on that path the country would be insolvent by 1991.² By the end of October leading economists judged that a cut in living standards of 25 to 30 percent was needed, but that it could not be imposed without risking the regime.²

On 1 November 1989 Egon Krenz briefed Mikhail Gorbachev in Moscow. According to the record published by the Cold War International History Project (https://zzf-potsdam.de/sites/default/files/mitarbeiter/hertle/2009_04_08_cwihp_bulletin_12_hertle_fall_wall.pdf), he said that foreign debt would reach 26.5 billion US dollars, or 49 billion valuta marks², by the end of the year. Income in convertible currency was 5.9 billion dollars against expenses of 18 billion, and interest alone cost 4.5 billion dollars, or 62 percent of annual export earnings in foreign currency.² The Factbook gave a lower figure for external debt, 20.6 billion dollars for 1989.³ The two numbers may measure different things, and we have not reconciled them.

The cost of earning hard currency was high. Using unpublished planning data for 116 combines, Akerlof, Rose, Yellen and Hessenius (https://www.brookings.edu/wp-content/uploads/1991/01/1991a_bpea_akerlof_rose_yellen_hessenius_dornbusch_guitian.pdf) calculate that in 1989 East German firms spent on average 3.73 marks, at producer prices, to earn one deutsche mark in sales to non-socialist countries. Such exports amounted to about 20 percent of GNP.⁷ The Valutamark was a statistical unit worth about four East marks, and exports to the West were credited at an internal rate of 4.3 marks to one deutschmark.⁵

The political break

The collapse came faster than anyone planned for. In 1989 the leadership had prepared to celebrate the 40th anniversary of the state. Hungary opened its border in September, Honecker resigned in mid-October and the Berlin Wall fell on 9 November.⁵ Emigration was heavy: 73,000 people left for the West in November 1989, 59,000 in December and almost 50,000 a month in the first three months of 1990.⁵

Monetary union in 1990: the terms

Monetary union was first raised in the political arena in mid-January 1990 as a way to slow the exodus, and the West German government presented it publicly on 6 February.⁵ The Bundesbank said on the same day that any such step lay in the distant future.⁵ Most economists agreed with the Bundesbank that union should wait for fundamental reforms.⁵

The East German elections in mid-March 1990 returned the Ost-CDU and its allies, and DIW's Brenke reads the result partly as a vote for the deutschmark. Afterwards, monthly departures halved.⁵ The terms were set in a treaty that took effect on 1 July 1990. The Bundesbank's later account (https://www.bundesbank.de/resource/blob/706190/ddf80f46a063f36065177cb012577e6e/mL/2002-03-circulation-mark-data.pdf) says wages and salaries were converted at 1:1⁸, assets in principle at 2:1, with a social component under which 2,000, 4,000 or 6,000 marks per person, depending on age, were exchanged at 1:1.⁸

DIW reports that, in practice, the conversion ratio for stock variables such as bank balances and debts was 1.6 to 1.⁵ The justification for the 1:1 rate on wages was that wages were only around one third of West German levels, and the Bundesbank's 2002 review adds that the 2:1 rate seemed justifiable because the inflationary overhang of money in the GDR was apparently relatively small.⁵⁸

Who wanted something else

In an open letter of 9 February 1990, the German Council of Economic Experts recommended that the planned-economy price system be dismantled first, the financial system rebuilt and state firms privatised, with a fixed exchange rate for the East German mark and convertibility phased in as soon as possible.⁵ DIW itself argued for a low conversion rate, as low as five East German marks to one deutschmark, which it expected to protect exports and attract investment.⁵ Some economists argued for a rapid union, because a common currency would set reliable prices and avoid exchange-rate risk for investors.⁵

1. 16 May 1989Schurer warns SED leaders that the GDR will be insolvent by 1991 at the current paceSource 2 (opens the source in a new tab)
2. 7 Oct 1989Honecker claims a modern economy among the ten most productive in the worldSource 5 (opens the source in a new tab)
3. 1 Nov 1989Krenz tells Gorbachev of 26.5 billion dollars of foreign debtSource 2 (opens the source in a new tab)
4. 9 Nov 1989The Berlin Wall fallsSource 5 (opens the source in a new tab)
5. Mid-Jan 1990Monetary union first proposed in the political arenaSource 5 (opens the source in a new tab)
6. 6 Feb 1990West German government presents the plan; the Bundesbank calls it distantSource 5 (opens the source in a new tab)
7. 9 Feb 1990Council of Economic Experts proposes reform first and a fixed rateSource 5 (opens the source in a new tab)
8. Mid-Mar 1990Volkskammer election returns the Ost-CDU and alliesSource 5 (opens the source in a new tab)
9. 1 Jul 1990Currency, economic and social union takes effectSource 8 (opens the source in a new tab)
10. Late 1990About 3 million of a labour force potential of 9.8 million are jobless, in schemes or pensioned offSource 5 (opens the source in a new tab)
11. End 1994Treuhandanstalt closes with reported privatisation losses of 260 billion DMSource 9 (opens the source in a new tab)

The strongest case against a fast 1:1 union

The evidence gathered after the event gives the argument some force. Akerlof and co-authors found that, at the wage and cost levels of late 1990, firms employing only about 8 percent of the industrial workforce could cover their short-run costs at world prices, which was 14 of the combines they studied.⁷ They also estimated that a 50 percent cut in labour costs would make 47 combines viable, employing almost 37 percent of the workers, and a 75 percent cut would make 88 combines viable, employing 77 percent.⁷

The consequence was swift. Within weeks of union, DIW reports, industrial production fell by almost 50 percent, which it calls historically unique.⁵ By late 1990 about three million of the 9.8 million people who had been counted as potential labour force were unemployed, on labour-market schemes or pensioned off.⁵ The authors of the Brookings paper described the start of a depression in the plainest terms.⁷

One of the worst and sharpest depressions in European history had begun.

— Akerlof, Rose, Yellen and Hessenius, Brookings Papers on Economic Activity, 1991

Wage policy compounded the problem. Wages in the second quarter of 1990 were 11 percent higher than in the first, before the union took effect, and in the metal and electrical industry pay rose by a good 40 percent in two steps by early October 1990.⁵ Akerlof and co-authors put the wage rise through October at 42 percent.⁷

The East Germany economy after union: collapse, then partial catch-up

Burda and Hunt, in the Brookings Papers on Economic Activity, summarise the first three years: from 1989 to 1992 GDP in the former GDR declined by roughly 30 percent, value added in industry by more than 60 percent and employment by 35 percent. Unemployment rose from officially zero to more than 15 percent, and to 33 percent if hidden unemployment is included.¹ More than 1 million people, 6 percent of the eastern population, moved west between 1989 and 1991.¹

How far the East caught up

Output per head recovered quickly at first. In Burda and Hunt's Table 3, eastern GDP per capita rose from 42 percent of the western level in 1991 to 64 percent in 1994 and 65 percent in 2000, while labour productivity rose from 44 percent to 73 percent.¹ Wages rose from 50 percent of the western level in 1991 to 76 percent in 1997, running ahead of productivity for most of the period.¹

Consumption converged faster than output, and Burda and Hunt attribute that to generous transfers from the west. They report that total financial transfers from the west exceeded 1.5 trillion marks over 1990 to 2000, an annual net transfer of about 5 percent of German GDP.¹ Hans-Werner Sinn, writing in 2000, reported that about one third of eastern spending came from the West and that labour productivity had stalled at roughly 55 percent of the western level.¹⁰ We could not confirm from Sinn's abstract how he defines productivity, so we do not reconcile his 55 percent with Burda and Hunt's 73 percent.

By 2013 the DIW found that eastern GDP per capita was 71 percent of the western figure, productivity per employee 79 percent and per hour worked 74 percent.⁶ Unemployment in August 2014 was 10.9 percent in the East against 6.6 percent in the West.⁶ The labour market had changed in other ways too: the employed share of the eastern working-age population fell from 83 percent in 1990 to 65.2 percent in 1999, while the western share was a steady 73 percent.¹ Births halved from about 200,000 in 1990 to just under 100,000 in 1994.⁶

The Treuhand and the combines

The state-owned combines were taken over by the Treuhandanstalt, a public trust set up to privatise them. Dierk Hoffmann of the Institut fur Zeitgeschichte writes that it handled about 12,000 enterprises, of which 30 percent were liquidated, and that only about a third of the original four million jobs remained.⁹ The labour market adjusted in several ways at once. Maier reports that East German industry cut working time for 900,000 employees between 1990 and 1991, that early retirement at 55 applied to perhaps 800,000 people after 1992 and that job retraining took another 400,000. By 1993 agriculture and forestry had fallen to one-fourth of its 1989 size and industrial employment to one-third.⁴ He adds that the total of unemployed, early retired, state-created jobs and retraining places was perhaps a third of the potentially employable, a total he compares with the Great Depression (https://therealigned.com/story/what-caused-the-great-depression).⁴ It carried legacy debts of about 120 billion marks after the currency conversion and reported privatisation losses of 260 billion marks when it closed in 1994, which Hoffmann says is only the lower end of the true cost.⁹