European Economy. Economic Papers. Germany's growth performance in the 1990's

tighter monetary conditions
looser monetary conditions

---

2.2 Budgetary policy in Germany in the 1990s
2.2.1 Immediate impact of re-unification
Following the two oil price shocks, the period from 1982 onwards was characterised by the
absence of major international turbulence in the economic field. Not least as a consequence of
the more favourable environment, general government finances improved from a deficit of 3.7%
of GDP in 1981 to a surplus of 0.1% in 1989; at the same time, the debt level fell to a value of
close to 40% of GDP
16
. The relatively favourable situation allowed for a reduction in income
taxes by DEM 50 billion implemented in three steps (1986, 1988 and 1990). The third and most
important step, which brought a net tax relief of DEM 25 billion was implemented on 1 January
1990. Following as it did the downfall of the Berlin wall by less than two months, the timing of
this third step was unfortunate because it coincided with the sharp rise in demand for West
German products and was therefore clearly pro-cyclical in nature.
The fast and unexpected re-unification, preceded by the introduction of the Deutsche Mark in
the GDR on 1 July 1990, put a huge strain on public finances due to three factors: First, the rise
in Eastern salaries was much faster than the rise in productivity, driving unit labour costs to
unsustainable levels, especially in the tradable sectors, which were immediately exposed to
international competition. With unemployment rising as a consequence, the complete
introduction
 
of the West German social security system meant that social security payments
surged, putting a huge burden both on the social security systems and on government budgets.
Secondly, the exchange rate of 1:1 implied that the debt of East Germany (including its public
housing sector and the debt of East German companies) was at least partially converted at this
high rate. It was ultimately the federal budget which had to shoulder most of the bill, because
the privatisation of East German enterprises via the Treuhand-Anstalt required large subsidies to
be paid in order to make the now overly indebted enterprises economically viable; the
cumulated losses of the Treuhand reached
 
DEM 210.4 billion in 1995, when they were
integrated into the overall government debt
17
. At the same time, the debt of the East German
public sector (DEM 102.6 bn. including Ausgleichsfonds Währungsumstellung) and part of the
debt of the housing sector (DEM 29.1 bn.) were directly added to the public debt. The overall
level of government debt, which had been slightly lower than 40% of GDP in 1989, and which
independent of the debt of the Treuhandanstalt had already risen to 49.4% in 1994, jumped to a
value close to the reference value of the Maastricht Treaty, i.e. 60% of GDP (Table 2.1).
Thirdly, the appalling state of infrastructure in the East meant that huge public investments were
necessary to allow the East to catch up with the West
. 
In addition, the federal government
granted important tax breaks for the construction of rental apartments and houses to bring
housing standards up to those prevailing in the West. However, these fiscal allowances turned
out to be a major burden on government revenues, because the reaction of income tax payers
was substantially stronger than anticipated by the legislator. Box 3 deals in more detail with
financial transfers to the New Länder.
16
In the following, no direct comparisons of public finance data of the 1980s with those for the 1990s will be
undertaken as the change from ESA 79 to ESA 95 has rendered many ratios not comparable (cf. also SVR,
1999/2000, p. 104)
17
As these losses were not part of the annual burden, they were not incorporated into the deficit figures of the
corresponding years. If these subsidies were integrated into the official deficit figure of the respective accrual
years, the deficit would have reached figures above 7% of GDP in the early 1990s.

---