Academic journal article International Advances in Economic Research

The East German Disease Revisited

Academic journal article International Advances in Economic Research

The East German Disease Revisited

Article excerpt

This paper attempts to explain the development of the East German economy since the political, social, and economic union with West Germany in 1990. An earlier contribution [Greiner et al., 1994] showed the different effects that produced joint deindustrialization in East Germany as an analogy of the well-known Dutch Disease phenomenon. This paper examines recent East German time series of main economic variables since 1994. Though the business sector and the unions are ever more willing to correct errors of the past, fiscal transfers from West to East Germany continue to exert their pressure on the tradeables sector. Economic policy should encourage savings in East Germany and gradually change the structure of (declining) transfers to expenditures that generate new capacities. (JEL E65, F15)

Introduction

This paper attempts to explain the development of the East German economy since the political, social, and economic union with West Germany in 1990. The background for this analysis is the paper on the East German Disease by Greiner et al. [1994]. In that paper, the different effects that produced joint deindustrialization in East Germany was shown as an analogy of the well-known Dutch Disease phenomenon (see, for example, Corden and Neary [1982] and Sell [1988]) which occurred in countries affected by a resource boom. The main objective of this paper is to further examine East German time series of main economic variables in order to foster the empirical evidence of the effects analyzed theoretically and empirically in the Greiner et al. [1994] paper. This paper attempts to answer the following questions. Is the decline of the manufacturing (tradeables) sector still going on or is there already an upward bounding movement along the J-curve with an increasing reindustrialization perhaps induced by successful policy measures? This paper is organized as follows. The second section serves to reintroduce the theoretical East German Disease concept, and the third section presents updated empirical evidence for this peculiar phenomenon. The exposition closes with some policy recommendations.

The East German Disease Theory: A Comprehensive Summary

Within the framework of the well-known Salter-Swan-Meade analysis [Salter 1959; Swan, 1960; Meade, 1951], Figure 1 characterizes East Germany's economic situation on the eve of the German monetary and economic union. There was a moderate deficit in the balance of trade [1] (corresponding to the distance, [D.sub.T] - [S.sub.T] and it was much more pronounced with a considerable amount of hidden unemployment (corresponding to the distance, [S.sub.N] - [D.sub.N]). The full employment locus ([S.sub.0]) in Figure 1 merely stands for the potential output. [2] It is important that the slope of [S.sub.0] signals to the producers the relative price between tradeables and nontradeables to which they will allocate the factors of production. The actual real output (Y) of the former German Democratic Republic (GDR) exists in the rectangle, [0S.sub.T][DD.sub.N]. Hence, it was smaller than real absorption (A) at a size of [0D.sub.T][CD.sub.N]. Thus, the condition for open economies (for the former GDR, more or less), Y - A = X - M, was fulfilled.

The former GDR suffered from a significant deterioration of the terms of trade when oil exporting eastern European countries began claiming international prices for their commodities, abolishing the huge subsidy element that was granted before to socialist-brother states. In the Salter-Swan-Meade diagram (see Figure 2), a deterioration of the terms of trade can be visualized by a downward shift in the production possibilities frontier. More precisely, a given amount of produced exportables is now changed against a smaller amount of importables. If tradeables are measured in units of importables, then the transformation curve will move from [EE.sub.0] to EE. [3]

In the subsequent analysis of the ostmark revaluation effects due to the chosen conversion rate (Figure 2), assume that the above-mentioned terms of trade effects were already accommodated by the East German economy. …

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