Business | Markets

Hamish McRae: Stumbles that were unexpected on path to European unity

 
End of an era: Berliners scale a section of the Wall in 1989
Hamish McRae
10 November 2014

It was the great symbolic moment, 25 years ago, in that series of events that led not just to a reunified Germany but to the European Union we have today.

Germany and the rest of Eastern Europe took very different paths in their transformation from command economies to a market one.

So we had one of those rare real experiments in economics: which path was better? But the story has another curious twist. Who could have predicted a quarter of a century ago that economic distress of the enlarged EU would not be among the accession states but in established core members such as Italy and even France?

The German model shows what can and cannot be achieved by huge subsidies from richer regions to poorer ones. When Germany reunified, it was agreed that the East German mark should be convertible one-for-one with the West German mark. The Bundesbank opposed this, arguing that a more appropriate conversion rate would be two-for-one, recognising lower productivity of the East.

Politics prevailed. The resulting surge in unemployment from a non-competitive exchange rate had to be offset by massive subsidies from the West. Add in the investment needed to bring crumbling infrastructure to West German standards and the annual transfer at times reached about 8% of GDP.

Thanks to the generosity of West German taxpayers, the gap has been narrowed but not eliminated. Infrastructure in the East is now pristine, yet the former East German states remain poorer, and westward migration continues. In Berlin, the gap is less obvious, as indeed it was before the Wall came down.

That is partly because the grander bits of the city were in the eastern sector, partly because cheap rents in the east have supported a vibrant artistic community. Elsewhere the fissures are still evident. It seems to take more than a generation to reverse the economic damage the communist system generated, even with an almost unimaginable transfer of wealth.

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Such transfers were not available to the rest of Eastern Europe. Those countries would eventually get some funds from membership of the EU but meanwhile they were on their own. They had to take a different route: devaluation and deregulation. The results have been uneven. There have been notable successes.

Poland was the only country in Europe to come through the last downturn without going into recession. Slovakia has become a large carmaker. Estonia is a pioneer in communications technology. But it has not been easy and the fact there are so many Eastern Europeans seeking work in the UK is a sign of the gap in opportunities that still exists.

So you can’t say one path was better or worse than the other, simply that the different countries had to do what they had to do. In the case of most, it was having to accept a sharp, though temporary, fall in the standard of living.

East Germany accepted a loss of control and the imposition of the standards of a very different society. A few weeks after the fall of the Wall, I spoke to Christa Luft, economics minister in the still-in-power East German government. She said she hoped elements of East German values would influence the West after reunification. It would not be a one-way street. I think most Germans would accept this has not happened.

The more prosperous parts of Germany have been affected in a different way — by having to sign the cheques. But while it might be acceptable to fund your kith and kin as a price for getting your country back together, having to support the living standards of profligate southern Europeans is a different matter. The opposition to back-door bailouts of the Club Med countries by the European Central Bank is rooted in the experience with East Germany.

It may in part explain German reluctance to help Britain in its efforts to hold down the price of EU membership. If we pay in less, someone else will have to pay in more. Who is that likely to be?

The frustration with the indebted countries of southern Europe is all the greater because of the sacrifices made by the German people in the early years of euro membership. Germany joined the euro at too high a rate and had to squeeze down its costs, and hold down living standards, to achieve its present competitiveness.

It had to push through the sort of internal devaluation now facing Italy, Spain and to some extent France. If it could do so, suffering the jibe of being “the sick man of Europe”, why can’t they? Germany, post-unification, is surely a success story, even if the process has proved far harder than thought.

Enlargement of the EU has been a success story, though perhaps a qualified one. So Europe has pulled the East in with the West. But what no one could have predicted 25 years ago was that Italy would be mired in recession year after year, or that half the youth of Spain would be unemployed.