The costs of German Economic Union

On July 1st, 1990, the former Soviet-controlled East Germany, liberated in 1989, was merged into the economy of West Germany as part of the reunification process. People gathered in their thousands outside banks at the stroke of midnight to cash in their low value Ostmarks for the hard currency Deutsche Marks.

The exchange rate was 1:1, whereas the real (black market) rate had been between 7 and 11 Ostmarks to each Deutsche Mark. The average sum exchanged was 4,000 marks per person. Of the 25 billion Deutsche Marks sent over ahead of the transfer, some 3.4 billion were handed out on the first day.

The changeover was applied to pensions, wages and savings as well, giving East Germans what was, for them, unprecedented spending power. They flooded to the West to buy Western goods of far higher quality than those they left unsold in the shops of the East. Many Eastern businesses closed, unable to compete once borders were opened. Factories ceased production, and unemployment soared. A government agency, the Treuhand, was established to oversee privatization of the East’s state industries.

Estimates for the cost of fiscal unification to Germany’s social system are put at about €1.5 billion, but there were dislocation and upheaval costs throughout the German economy, costs that reverberated for years to come.

The decision to unify was a political one that was opposed by some Western powers who feared that a unified Germany would unbalance the EU with its huge population and economic strength. The careful balance between a France and a Germany, previously roughly equal in size, would be upset. A larger Germany would demand greater voting power, and could be expected to dominate the EU economy.

The decision to offer an exchange rate of 1:1 was also a political decision. It was controversial in West Germany because it was far out of accord with economic reality. Chancellor Helmut Kohl wanted the full co-operation of the East in the reunification process, however, and knew that a 1 for 1 offer would secure that. Some critics described it as a bribe. Kohl knew it would cause major dislocation, but took the long-term view that when things settled down, Germany would still be united. The subsequent outturn proved him correct.

The parallel today might be with Brexit. East and West Germany had been separate for four-and-a-half decades, and a change in that relationship had to face upheaval as they adjusted to the new status. The UK has been a member of the EU for a similar period of time, and there have to be adjustments on both sides as that relationship is changed. There will be temporary dislocation and upheaval as the UK adjusts to the new reality, just as there was with German reunification. But at the end of it, the UK will still be outside the EU, just as Germany remained united. It will settle into a new role as an independent player on the world stage, and will most likely prosper accordingly.