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

0. Executive summary
Economic growth in Germany has been lacklustre since the mid-1990s …
Since the mid-1990s, output growth in Germany has been lacklustre: between 1995 and 2001
growth averaged 1.6% per year. This is almost 1 percentage point below that of its partner
countries in the EMU/EU area, even if the faster growing cohesion countries (i.e. Spain,
Ireland, Portugal and Greece) are excluded from the comparison. The only year where this
gap was notably smaller was 2000 when an unprecedented export boom propelled output
expansion close to the European average. But the growth momentum faltered again in 2001 as
the international economy slowed. With the German economy relapsing into slow motion the
growth gap re-emerged and there are little signs that this would change in 2002.
… and the economy has proven highly vulnerable to external shocks.
Subdued economic activity has been accompanied by a strong volatility of output growth. The
most recent downturn in 2001-02 completes already the third full cycle since the recession of
1993. For each of these three cycles the downward movement was triggered by an
international crises, in particular the Mexican crisis in 1994, the Asian crisis in 1997/98 and
the oil price hike in 1999/2000. Although Germany’s European partners were also adversely
affected by these shocks to the world economy, output growth of these economies proved
much more resilient. Evidently, compared to its European partners in Germany these adverse
shocks were propagated much more directly and unmitigated.
This is due partly to long-lasting effects of re-unification, …
Slow growth of domestic demand, essentially of private consumption and construction
investment, is the key factor behind the weakness of GDP growth in Germany. On the supply
side, this weakness is reflected by a very low contribution from employment to output
growth. Long-lasting effects of re-unification seem to play a pivotal role in the twin
phenomenon of sluggish domestic demand and anaemic job growth. Indeed, re-unification
brought together one of the most advanced economic areas of the world with an area of low
productivity, state-protected companies, artificial exchange rates and an almost obsolete
capital stock. The clash this implied for East German production was enhanced by a 1:1
conversion rate of the East German mark into the DEM, while the exchange rate applicable
for East German exports had been at 1 to 4.3. In addition, in the initial years eastern wages
rose far beyond productivity gains. This was due partly to the specific wage bargaining
situation, where labour unions and employers’ associations from the West oversaw the
negotiations in the New Länder, but also to political reasons such as equality consideration
and the attempt to prevent a massive outward migration. The consequence was a near collapse
of those sectors of the economy that were exposed to West-German and international
competition, particularly the manufacturing sector, with a dramatic labour shake-out and
skyrocketing unemployment as a result.
… with the construction sector in the East particularly affected, …
In spite of this, in the initial years after re-unification output growth in the New Länder was
higher than in the West. In part this is explained by a catching-up effect following the drastic
fall in output at the start of re-unification. But even more so it was the result of a composition
effect, with the building sector giving a disproportional contribution to growth in the New
Länder in the first half of the 1990s. This was partly due to reconstruction needs related in
particular to the area of infrastructure, but it also resulted from very generous fiscal incentives
for both business and housing construction. When in the mid-1990s infrastructure investment
levelled off and fiscal incentives were reduced, construction investment in the New Länder

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imploded, imparting very negative contributions to growth ever since. As a consequence,
growth rates in the East have fallen short of those in the West from the mid-1990s onwards.