Berlin Wall

Jörg Bibow | November 12, 2014

Germany is celebrating: it is 25 years ago that the Berlin Wall came down, marking the end of Stasi tyranny, and much more than that. No doubt that is reason to celebrate, for Germany, Europe, and the world. As a German and European, I am celebrating too.

Alas, this is also an occasion for hearing that tiresome story again about how costly and burdensome it was for Germany to reunite. For instance, Terence Roth writes a piece in the WSJ titled “After Fall of Berlin Wall, German Unification Came With a Big Price Tag.” Now, this kind of statement really needs to be qualified, especially as the myth about the “burden of unification” paved the way for yet another German myth a few years later that has proven rather catastrophic for Europe: namely, the myth that Germany had to “restore its competitiveness,” which it apparently had lost in the context of reuniting. Undisturbed by any doubt or reason, the German authorities live in their mythical world of economic virtue and vice, famously referred to by finance minister Wolfgang Schäuble as his “parallel universe.” Let’s try to get the matter straight then.

To begin with, it is unquestionably true that German unification came along with a big price tag. But the price Germany ended up paying was only partly due to the wreckage that communism had produced in the east. The macroeconomic policy response, featuring ultra-tight money and mindless fiscal austerity, proved far more costly. In 1991, both Germany’s consumer price inflation and budget deficit as a share of GDP were about 3 percent. Imagine the Federal Reserve responding to the historical challenge and responsibility of national reunification by monetary overkill—which is exactly what the Bundesbank chose to do, hiking rates to 10 percent and pressuring fiscal policy into sharp tightening too. Ironically, this counterproductive macro policy mix pushed headline inflation up, apart from crushing growth. As a consequence, on top of the legacy of wreckage in East Germany, unemployment in former West Germany doubled as 1.5 million jobs (5 percent of the labor force) were destroyed. Unsurprisingly, Germany struggled until 1998 to get the budget deficit back to just below 3 percent. Only the smaller part of the rise in Germany’s debt ratio from 40 to 60 percent of GDP over the 1990s owed to East German legacies (see here and here).

This is not where the story ends though. Germany repeated the exercise of mindless fiscal austerity in the 2000s when Germany became known as the “sick man of the euro.” Once again, unemployment soared and the debt ratio rose further, toward 70 percent of GDP. It was only when Germany had deflated itself to super-competitiveness and ramped up a current account surplus of 7 percent of GDP just prior to the global crisis that Germany finally balanced its public budget. Alas, the counterpart to that fateful endeavor was that Germany’s euro partners lost their competitiveness, ending up in severe crisis as a consequence of the external debts taken on to pay for Germany’s notorious export surpluses in due course (see here and here).

Today, Germany’s public debt ratio may be just under 80 percent of GDP, but elsewhere in the stagnant eurozone it is close to 100 percent on average—and still rising. Hence the German authorities are prescribing more of the same medicine: austerity without any consideration of the growth consequences, even as parts of the eurozone have meanwhile sunk into debt deflation. Not everyone seems to understand that blindly repeating the same exercise while expecting different outcomes amounts to insanity. The German authorities see their prescriptions as virtue. Germany’s balanced budget in the middle of continent-wide ruin is seen as ultimate public wisdom—even if it amounts to a collective economic suicide attempt.

The big price tag that came along with the legacies of tiny East Germany, the so-called burden of German unification, pales in comparison to the wreckage that German macroeconomic policy folly has inflicted upon Europe ever since, and continues to do so today. Europe is still not tiny though. There are important global repercussions of the German-led policy blunders across the Atlantic that may well come to derail the much-hoped-for full-swing recovery of the U.S. economy.

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  1. Comment by Stavros Koiladitis — November 13, 2014 at 9:53 am   Reply

    God bless you for this very informative piece and the links, which I shall have to check out more thoroughly. I must say, it takes a German to explode German economic fairytales. With you and Prof. Heinrich Flassbeck, all hope is not lost for economic sanity amongst German economists.

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