Q&A: How Economically Successful Was German Unification? - "The Aging Population Will Become an Ever-Greater Obstacle to Growth"

Twenty-five years ago, the German Democratic Republic imploded, opening the way for the unification of the two German states. What had been only a political dream became a reality. However, from that time until now, economists’ projections for the future of a unified Germany have diverged widely, depending on their point of view and location. Why are we still left waiting for the full convergence of East and West? ZEW financial expert Friedrich Heinemann explains what ails the East German economy, its particular opportunities, and the potential importance of immigration for its future growth.

Politicians like to emphasise that the unification of West and East Germany since 1990 represents an economic success story. Is this really the case?

Indeed, there have been many successes, and just strolling through downtown Erfurt or Leipzig, one cannot fail to recognise them. In terms of infrastructure, quality of life and tourist appeal, the Eastern German states are, in fact, a success story. Moreover, it has been possible to revive several industrial centres. Today’s share of the industrial sector in value creation in Eastern Germany exceeds that in France. Nevertheless, economists have good reason to dampen the festive mood on the occasion of the 25^th anniversary celebrations: the per-capita net domestic product in Eastern Germany remains a third below the Western level, and the chances for further recovery seem questionable. The shrinking and rapidly aging population is becoming an ever-greater obstacle to growth.

To this day, public and private budgets in the Eastern part of Germany are continuing to receive significant transfers through financial equalisation and social security. Even so, the Eastern states have been lagging behind the West for years, for example, in terms of the unemployment rate and wage levels.

This should remind us of the experience of other nations, something to which one should pay close attention in all European decisions: high transfer levels are by no means a guarantee for economic convergence, and they can even have the opposite effect. Generous transfer payments reduce the recipients' incentives for innovations, to make their locations attractive for firms or to adhere to wage policies in line with regional productivity. In addition, even with the wisest investment support is it very difficult to compensate for poor starting conditions such as the lack of mid-sized and large enterprises.

Another critical juncture relates to tax revenues in an East-West comparison. The fiscal differences between the new and the old federal states bring along enormous redistribution effects. Will financial equalisation after 2020 still require enhancement through a new solidarity agreement?

The original solidarity agreement was based on the necessity to fund the build-up of adequate infrastructure for the new federal states. This mission has now been largely accomplished and the system should return to the "normal" mechanisms of financial equalisation. The standard financial equalisation system provides extensive compensation for the much lower tax revenues in Eastern Germany. With the exception of Berlin, the Eastern states do not have excessive state debt. For this reason, special treatment is no longer advised. To create future incentives, it would be particularly helpful for the Eastern states to grant greater tax autonomy to the subnational level. This should be done for important types of taxes such as the income tax rate.

What can be done in the future to turn a political commitment to the vision of "blossoming landscapes" throughout the nation into more of a reality?

The Eastern states have major opportunities for growth through new growth centres such as Berlin, as well as Dresden and Leipzig. Regional economic policy in the East German states should be strategically aligned to derive greater benefit from these centres. Given the very problematic demographics in the East, it makes no sense whatsoever that there is often greater political resistance to immigration in this area than in the West. If such opinions were governed more by reason and less by emotions, the East should actually be especially enthusiastic about every young person who immigrates there. What’s more, in the current tide of over-regulation, economic policy-makers should remember the great risks involved, in particular for the new states: a nationwide minimum wage, for example, is much likelier to be a hindrance to new job creation in Frankfurt an der Oder (in East Germany) than in Frankfurt am Main (in West Germany).