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

first euro years
(1999-2001), which were characterised by improving price and cost
competitiveness driven by the depreciation of the euro vis-à-vis the US dollar and the
currencies of other trading partners. The weakening of the euro partially offset the effects of
the fall in the DEM/USD exchange rate towards the end of 1998.
Developments within the Euro Area
Figure 3.2 shows the same REERs limited to the countries of the Euro-area. While in the first
half the 1990s developments were in parallel with those for the larger reference group, the
picture has changed thereafter. Changes in the Euro-area based indicators have become smaller
than those based on the larger group of countries, in particular if measured in terms of relative
unit labour costs for the manufacturing sector.
Figure 3.1:
Real Effective Exchange Rates vis-à-vis a Group of 24 Industrialised Countries
75
80
85
90
95
100
105
1989
1991
1993
1995
1997
1999
2001
Deflator of private
cons umption
GDP deflator
Price deflator of exports of
goods and s ervices
Nominal unit labour costs in
the whole economy
Nominal unit labour costs in
manufacturing
Figure 3.2:
Real Effective Exchange Rates vis-à-vis other EU Countries
75
80
85
90
95
100
105
1989
1991
1993
1995
1997
1999
2001
Deflator of private
cons umption
GDP deflator
Price deflator of exports of
goods and s ervices
Nominal unit labour costs in
the whole economy
Nominal unit labour costs in
manufacturing

---

This is suggestive of the fact that fluctuations in nominal exchange rates have played a major
role in the development of the REER of Germany. Indeed, although exchange rate fluctuations
between Euro-area countries have been constrained within the EMS system, a substantial part of
the rise in the REER vis-à-vis these countries during the first half of the 1990s was due to the
nominal appreciation of the DEM (Figure 3.3).
However, the DEM also rose in previous periods without causing serious problems for German
competitiveness. But, in the past, a nominal exchange rate appreciation was generally balanced
by a slower increase in nominal unit labour costs, which over the long run kept the real effective
exchange rate down; relative wage moderation thus kept the export sector afloat.
By contrast, in the first half of the 1990s, on top of a substantial rise in the nominal exchange
rate vis-à-vis the other Euro-area countries currencies, Germany’s trade unions gave up their
customary restraint with the effect that during this period nominal unit labour costs rose faster
than those of other European countries. This contributed decisively to the severity of the
recession, which the German economy experienced in 1993, and worsened the price
competitiveness of the German economy leading to a loss in export shares, which the country
has not recovered since.
The low external value of the euro in recent years has eased the competitiveness problem vis-à-
vis non-Euro-area countries and allowed to regain to some extent previously lost export market
shares. In addition, since the mid-1990s, not least due to the record unemployment levels,
Germany witnessed a significant degree of wage moderation. However, as nominal unit labour
costs in other Euro-area countries were also rising only relatively slowly, the gain in cost
competitiveness has been painfully slow. The high costs have kept Germany from recovering
the market share it once had. Much less could the country increase its market share in
accordance to its larger economic weight due to re-unification. In fact, as will be seen below, it
is exactly the East German enterprises that suffered the most from the high effective exchange
rate, because only very few East German, products were able to compete based on quality. The
rest needed to compete on the basis of lower cost, which due to high wages and despite massive
subsidies from the West, many enterprises have found next to impossible.