Lessons We Can Learn On How Stimulus And Jobs Programs Failed in Eastern Germany

"I have this to say to my fellow Germans in East Germany: The introduction of the social market economy offers you every chance, in fact, even a guarantee, that (the East German states of) Mecklenburg-Western Pomerania, Saxony-Anhalt, Brandenburg, Saxony and Thuringia will soon become blossoming landscapes in Germany once again."

-Helmut Kohl, 18 May 1990

As I put it in May: "Forget about blühende Landschaften [blossoming landscapes] in the former East Germany. Try depression." Almost twenty years after former German Chancellor Helmut Kohl made his remarks, there remains a wide gulf between the former DDR’s economic development and the development in the rest of Germany – this, despite a massive amount of money sunk into eastern German infrastructure and jobs programs.

On Monday I wrote Why Stimulus Is No Panacea, pointing to the misallocation of resources that stimulus can create. I see eastern Germany as the biggest real-time experiment in stimulus spending we have in the developed world. I want to use the experience as a case study in the limits of stimulus spending and jobs programs in ending a depression.

The State of Eastern Germany Today

When I was covering the euro crisis earlier this year, I outlined the genesis of Germany’s labour market problems in Germany’s 1990 currency union with my May post "The Soft Depression in Germany and the Rise of Euro Populism."  [Update: Moreover, based on reader input I should also note that the collapse of the Soviet Union was a major blow to East German trade and plans drawn up for East German business prior to the currency union.]

However, just yesterday Der Spiegel wrote a remarkably comprehensive piece on this topic that we can use as background. I have linked the full article at the bottom. It is in English and a must-read piece of journalism.

Here’s what they ask at the outset:

July 1 marks the 20th anniversary of the introduction of the deutsche mark in East Germany in the runup to full reunification. But the economic benefits that West German politicians promised failed to materialize. What went wrong?

We can get to what went wrong in a minute. But, detailing the problems is key to understanding how wide the gap is between east and west.

Today, the eastern German economy is still in a sorry state, and there are no indications that the situation will change. An estimated €1.3 trillion ($1.6 trillion) have flowed from the former West Germany to the former East Germany over the last 20 years. But what has that money achieved? Historic neighborhoods have been restored, new autobahns built and the telephone network brought up to date, but most of the money was spent on social benefits such as welfare payments. The anticipated economic upswing failed to materialize.

Some eastern cities, like Leipzig, Dresden, Jena and Erfurt, have experienced economic development. The state of Thuringia has a relatively robust auto industry, and there are successful high-tech companies in Saxony. Research institutes and universities are doing well, thanks in part to generous government subsidies.

But the success stories are rare. Most of eastern Germany has turned into an economically depressed region that lags behind the west in all respects:

  • The per capita economic output in the east is only at 71 percent of the western level, with a disproportionately high share of economic output attributable to the public sector. The economic output generated by the private economy is only at 66 percent of the western level.
  • To close the gap, the eastern German economy would have to grow more rapidly than in western Germany, but precisely the opposite is the case. Germany’s leading economic research institutes expect the economy in eastern Germany to grow by 1.1 percent this year, compared with 1.5 percent in the west.
  • Since the fall of the Berlin Wall, the population of eastern Germany has declined by almost 2 million people, a trend that is continuing unabated.
  • The proportion of household income derived from welfare payments is 20 percent higher in the east than in the west.
  • Of Germany’s 100 largest industrial companies and 100 largest service providers, not one has its headquarters in eastern Germany.

The Investment in Infrastructure and Jobs

So, it’s not that investments weren’t made. They were. Trillions were spent to upgrade infrastructure and create a modern environment in Eastern Germany. Eastern Germany has beautiful new airports and roads, which are better in many places than in the western states. Hundreds of Billions went into constructing and upgrading housing in eastern Germany too – so much so that housing is now being demolished due to the inventory overhang. Lots of money went into subsidies for aquatic resorts to boost tourism. For instance, in the state of Brandenburg alone, "close to €170 million in subsidies had been spent on swimming pools by 2005."

And then there are the Arbeitsbeschaffungsmassnahmen, one of the longest words you will ever see. This is the German word for public works programs. And they were maintained in droves in the former DDR. Spiegel says:

The government came up with a series of publicly funded employment programs in the years after the fall of the Wall. But there was always an underlying contradiction. On the one hand, the jobs created under these programs were designed to resemble normal jobs as closely as possible, so that participants would be able to eventually return to the regular working world. On the other hand, this parallel labor market could not compete with the real job market.

It was not a success, as Germany’s Federal Audit Office concluded two years ago in a devastating assessment of one such program involving so-called "one euro jobs." Under the scheme, the long-term unemployed could work a certain number of hours a week in, for example, old people’s homes, schools or parks. In return, they received compensation of €1 an hour or more on top of their regular welfare payments. But, according to the report, the government-funded ersatz jobs were displacing many regular jobs and even decreased the chances of participants finding real work.

For the majority of long-term unemployed people, the one-euro jobs did not "provide any measurable advantages" in terms of finding work, the auditors concluded. Hundreds of thousands of East Germans were "branded as second-class workers," says Esther Schröder, a former SPD member of the Brandenburg state parliament.

Yet, per capita output is still less than three-quarters of that in the West – this, despite a large outflow of population from east to west.

What went wrong?

Twenty years is a long time. On Wednesday I noted in "Questions On Whether Internal Devaluation Will Work For Europe" that East German unemployment is still double digits today. The chart from Spiegel shows you the progression both of unemployment and relative productivity.

The Germans have been very diligent in making the investments. It’s not like in Japan, where during their lost decade they continuously downshifted into deficit hawk mode. In my view, the investments made into the former DDR present the best case scenario one can hope for regarding stimulus and public works programs.

Why hasn’t it happened for eastern Germany? Claus’ piece Demographics and Macroeconomics – Part 1 (Wonkish) says there is a lot missing in Economics regarding growth theory. But here are some potential factors.

  • Time: eastern German workers were living in a much less technologically advanced world than in the west. They face a challenge similar to the one the southern states in the US have faced for two generations in terms of raising productivity levels. Time seems to be bringing the south in line. I don’t have the numbers with me. But I believe there is still a gap – although greatly diminished. Perhaps someone can provide the numbers for me.
  • Capital: if you look at the UK and productivity or GDP per capita, clearly there are is a huge gulf due to the lingering effects of de-industrialisation in the north. My sense is that more private sector capital has flowed to the south east (and into financial services) because of this. Perhaps the same is true in Germany i.e. less private sector capital flows to the east. The same could be said for the Ruhrgebeit in North Rhine Westphalia, which is Germany’s industrial heartland – where unemployment is high. But given the huge public sector and subsidised capital the east has received, you have to wonder if this has been malinvestment.
  • Cost of labour: my suspicion is that eastern German workers priced themselves out of competitiveness vis-à-vis their more productive western brethren. And to the degree that the west’s labour costs were too high, there was always the lure to German firms of Poland, Romania or the Czech Republic where labour costs were lower than in the east. I see this as the fundamental problem. Once the cost of labour becomes too high, a vicious cycle of lowered productivity and emigration of human and private financial capital ensues. In the American south, we are now seeing the return of capital as new businesses have formed.

If anyone has other thoughts, please supply them in the comments.

Lessons for Other Countries

High debt levels and the structural adjustments due to the misallocation of resources are the major reasons we are in an economic fix right now in Spain, Ireland, the UK and the US. Until the structural shifts occur, nominal GDP growth will remain well below potential. And this is poison for an economy with high aggregate debt levels as it changes the psychology of households and businesses to a fixation on debt reduction, precautionary savings, and cash hoarding (see Chart of the day: Record Profits But Cash Hoarding In The U.S.). While increased savings is what we want over the long-term, the reduced consumption and employment that results from it means slower growth for the foreseeable future.

In Spain and Ireland, there is no way to get around the lack of competitiveness without internal devaluation given the euro fixed exchange rate. In the US, we see massive out-migrations from depressed regions to more buoyant regions because of the common language that fosters a relatively greater labour mobility. Is this what we should expect from Spain or Ireland (or Greece)?

In Europe, the euro is a major reason why I am siding with the Germans on fiscal consolidation. But the UK and the US have a lot more leeway. So, in the United States and the United Kingdom, because of the sovereign currency, the lessons of eastern Germany go to stimulus and work programs. My takeaway is that stimulus can indeed create new malinvestment. Reading the Spiegel article should give you the sense that all the new airports, housing, spas and swimming pools are not adding to productivity. Moreover, the investments must be maintained and this siphons scarce financial and labour resources away from other uses. China, as a developing economy, may be able to handle this. But  the US or the UK cannot.

I do not support austerity. The reasoning seems to be: "we need to cut our spending now before the bond bears come a-calling and interest rates go through the roof." I think the logic behind this is flawed as it relies on non-existent bond vigilantes jacking up interest rates (see here). Treasury yields are in freefall right now.

At the same time, while stimulus can prevent a deflationary spiral, its supposed benefits are overplayed. I like to think it can be a boost in the short-term as the economy "re-calculates." Longer-term, there are negative side effects. I can point to the former DDR as a prime example of why. We are in a longer-term deleveraging that is only going to be exacerbated by the debt stress associated with high debt levels and low nominal growth rates, something Bill Gross seems to understand. There is no way around this via stimulus.

Source: Germany’s Disappointing Reunification: How the East Was Lost – Der Spiegel

47 Comments
  1. Max says

    Stimulus spending is too important to be left to governments.

  2. hbl says

    Ed,

    Excellent piece… this topic deserves a lot more discussion and tying in Eastern Germany is a useful case study in the effectiveness of jobs programs, though no doubt there will be disagreement on what is to be learned from this case. (I’m not sure what I think yet without learning more details about how the programs were done).

    With respect to your factors… time must play into it to some degree, as both graphs do show an improving trend. Cost of labor may be relevant especially since Spiegel seriously questioned whether the 1990 currency alignment should have been at par.

    I was curious if Bill Mitchell had written on East Germany and all I see is a comment from April 2009 here: “The fact that today the differences in standards of living are vast between the East and West parts indicates they have not spent enough as yet. Much more public infrastructure is needed in the East and more public jobs to alleviate the unacceptable levels of persistent unemployment.”.

    So that suggests another possible factor to add to the list: “degree”. It seems it must be far from a FULL “job guarantee” given that unemployment remained so high. Of course to the extent that you are correct to label some of the results “malinvestment”, more spending would add to the malinvestment. I wonder whether this program really is the “best case scenario”. I wonder if we can elicit comment from Bill or others who have written in detail on job guarantee policy.

    And where is Marshall’s reply to your post? :)

    1. Edward Harrison says

      hbl,

      I am disappointed to learn that Bill Mitchell’s response is that they need MORE investment. There has been – if anything – over-investment in Eastern German public infrastructure.

      To me, this is exactly, the problem people have with the stimulus approach. If things don’t turn around, the pro-stimulus analysts say, “see, you should have done more.” I know the situation in Eastern Germany very well. There was a solidarity tax, Arbeitsbeschaffungsmassnahmen, one euro jobs, the whole bit. You could not ask for a better program of Keynesian stimulus. To argue that the program failed because there wasn’t enough is simply not credible. There may be other factors, but this is not one.

      I also strongly suggest you read the Spiegel article in its entirety. It is terrific and may help shed more light on what I am saying. Let’s see what Marshall has to say.

      P.S. – I still do favor some stimulus but I readily admit it has limits and is no panacea when structural problems that take time to resolve are at issue. I would go as far as to say that applying stimulus can retard the necessary structural changes if done the wrong way.

      In my view, it was the cost competition from Eastern Europe which killed Eastern Germany. 15 years ago, I would pick up a product from Braun or Miele and it would read “Made in Germnay/Made in West Germany.” Today, you can read “made in Hungary.” You can see this even from the US. Do this at a local Williams-Sonoma or the housewares section of Bloomingdales and you’ll see what I am talking about.

      1. Marshall Auerback says

        You could have encouraged consumption. God forbid that the Germans should
        enjoy the fruits of their economic output!

        And I have responded to your other arguments at greater length elsewhere.

        In a message dated 7/3/2010 11:18:05 A.M. Mountain Daylight Time,
        writes:

        Edward Harrison wrote, in response to hbl:

        hbl,

        I am disappointed to learn that Bill Mitchell’s response is that they need
        MORE investment. There has been – if anything – over-investment in Eastern
        German public infrastructure.

        To me, this is exactly, the problem people have with the stimulus
        approach. If things don’t turn around, the pro-stimulus analysts say, “see, you
        should have done more.” I know the situation in Eastern Germany very well.
        There was a solidarity tax, Arbeitsbeschaffungsmassnahmen, one euro jobs, the
        whole bit. You could not ask for a better program of Keynesian stimulus. To
        argue that the program failed because there wasn’t enough is simply not
        credible. There may be other factors, but this is not one.

        I also strongly suggest you read the Spiegel article in its entirety. It
        is terrific and may help shed more light on what I am saying. Let’s see what
        Marshall has to say.

        P.S. – I still do favor some stimulus but I readily admit it has limits
        and is no panacea when structural problems that take time to resolve are at
        issue. I would go as far as to say that applying stimulus can retard the
        necessary structural changes if done the wrong way.

        In my view, it was the cost competition from Eastern Europe which killed
        Eastern Germany. 15 years ago, I would pick up a product from Braun or Miele
        and it would read “Made in Germnay/Made in West Germany.” Today, you can
        read “made in Hungary.” You can see this even from the US. Do this at a local
        Williams-Sonoma or the housewares section of Bloomingdales and you’ll see
        what I am talking about.

        Link to comment: http://disq.us/fvbmv

    2. Marshall Auerback says

      Okay, challenge accepted. As is often the case, Ed has unleashed his
      “inner Austrian” and I think he’s missed some very important things in the
      process. But the reunification story is an important one for many reasons,
      not the least of which is that I think this is the model that the Germans
      (and, by extension, the ECB) wants to deploy for the periphery nations. At a
      Levy Conference in 2009, Deutsche Bank’s chief economist, Norbert Walter (a
      highly influential figure in Germany), acknowledged as much.

      Now to my critique.
      First of all, it’s not so much that East German workers “priced themselves
      out of competitiveness” as Ed indicated, so much as that they were “bought
      in” to West Germany at the wrong price. Kohl reunified the countries at a
      1:1 exchange rate, which given the state of East Germany’s economy, was
      ludicrous. It provided an immediate incentive for German companies to go
      elsewhere to less costly countries in eastern Europe.

      I also think Ed mischaracterises the fiscal stimulus somewhat because the
      German government was not nearly as fiscally aggressive as Ed implies.

      True, from 1989 to 1991, the German government deliberately relied on
      borrowing to take up almost the whole of unification’s fiscal brunt.

      HOWEVER, starting in 1992 and under mounting pressure from the Bundesbank,
      the government began to introduce a series of new fiscal measures aimed at
      cutting its borrowing requirements. Between 1992 and 1995 a cumulative
      fiscal tightening occurred that was far in excess of initial borrowing
      requirements. A study by Heilemann and Rappen (1997) estimated that by 1995, the
      total effect of expenditure savings and increases in tax and social security
      contribution rates was sufficient to finance almost the whole of gross
      fiscal transfers amounting to DM 180 billion. Yet by 1996, Germany’s deficit
      ratio stood at 3.4 percent, well above the deficit ratio in 1991.

      A glaring fiscal paradox emerges here. Clearly, something must have gone
      seriously wrong.

      The practice of German fiscal policy over the recessionary 1992-97 period
      began with cuts in structural deficits at the onset of recession in 1992
      (sound familiar?). Tax hikes and expenditure cuts were undertaken with the
      intention of reducing public borrowing. These measures were enacted under
      mounting pressure from the Bundesbank, which argued that cuts in public
      borrowing were needed to prevent inflation. Rather than preventing inflation,
      however, these measures caused inflation. Hikes in indirect taxes and
      government-administered prices pushed headline CPI inflation higher, peaking at 4.0
      percent in 1992.

      Moreover, as a result of the recession’s onset in 1992-93, borrowing
      requirements soared. In response, new rounds of indirect tax and administered
      price increases were implemented by the government, with the intention of
      keeping borrowing requirements low and pressure from the Bundesbank at bay.
      These actions caused further “tax-push” inflation before the inflation rate
      fell rather sluggishly to below 2 percent by
      1995; this, in turn, discouraged the Bundesbank from monetary easing and
      encouraged ongoing pressures for continued fiscal consolidation. Another
      far-reaching consequence of this bizarrely inconsistent policy was higher wage
      inflation.

      While the economy deteriorated, the budget deficit failed to improve.
      Essentially, the worsening financial balances overcompensated for any
      improvement in structural balances. Consolidation efforts failed, as the
      destabilized economy (and cyclical balances) backfired on the
      budget.

      After six years of consolidation efforts, the deficit ratio finally
      improved to 2.6 percent in 1997, enabling Germany to meet the Maastricht hurdle
      of 3 percent. But this was largely a function of the improvement in the
      external sector. Strong growth in the United States and other trading partners
      proved highly instrumental in preventing Germany from slipping into
      another outright recession.

      I can do no better than quote the words of the economist, Joerg Bulow, who
      said:

      “The initial sharp rise in deficit spending in 1990-91 as a result of
      unification was both inevitable and not out of line with economic theory. The
      fiscal boost helped to stabilize noninflationary domestic demand growth in
      Germany at a time when other countries were experiencing a recession.
      However, a key fiscal mistake occurred when an ill-timed and overly ambitious
      consolidation crusade by the government began in 1992.

      Moreover, the long run of tight money orchestrated by the Bundesbank
      between 1990 and 1995 magnified the counterproductive effects of fiscal policy.
      The Bundesbank was the primary source of pressure for fiscal consolidation
      at any price, since it based its reputation on maintaining very low
      inflation. Ironically, the Bundesbank’s deflationary quest proved to be
      counterproductive, as the overall fiscal tightening and deterioration of public
      finances after 1992 were far in excess of what would have been required to cope
      with the challenges and responsibilities of unification. At the most
      critical stage, the Bundesbank’s argument that fiscal consolidation would prevent
      inflation did not hold, and measures undertaken to cut borrowing actually
      pushed inflation higher. With recession, public finances deteriorated and
      inflation declined rather sluggishly, owing to continued tax-push inflation.

      Unfortunately, this did not stop the Bundesbank from squeezing inflation
      down to zero by
      1999. As a result, the period from 1993 to 1999 stands out by far as
      Germany’s worst
      economic performance on record. The stark consequences of high
      unemployment, slow
      growth, and fiscal deterioration, however, were anything but inevitable.
      To an important extent, Germany’s structural problems today are a
      reflection of these
      unsound fiscal and monetary policies. The country (and Europe) paid a dear
      price for a
      policy experiment based on doctrines and beliefs whose relation to economic
      theory was
      anything but clear.”

      Sound familiar everyone?

      In a message dated 7/3/2010 11:08:16 A.M. Mountain Daylight Time,
      writes:

  3. Edward Harrison says

    The fact is that Kohl sold the East Germans down the river given the 1:1 exchange rate.

    But it was the Lohnangleichung in which eastern German workers were priced out. It’s not my mischaracterization that the eastern workers themselves wanted this because they argued against the original two-tiered salary system instituted post-unification. they wanted a unified common union-sanctioned salary in east and west and this is what eventually happened via the Angleichung.

    Moreover, irrespective of the fiscal situation, the fact is that the Germans continued unabated transfers to the east via the solidarity tax. What we should be looking at is relative wages and relative unemployment rates and this is where the problem lies. Since the fiscal transfers continued unabated, you would expect to see a closing of the unemployment and wage gap. You did see the wage gap close but the unemployment gap did not. To me this speaks very much to the pricing out of east German labour and the resulting unemployment.

    Honestly, I find it hard to think these facts are disputed.

  4. Edward Harrison says

    Remember, the solidarity tax and fiscal transfers were unabated. So we should be able to see the gaps closing due to the programs. Again, the key is RELATIVE wage and unemployment rates. Any system-wide fiscal policy should have impacted both west Germans and east Germans and is irrelevant.

    What you see is a Lohnangleichung – increasing wage parity – due to an orchestrated policy by the unions at the behest of eastern workers. But the unemployment gap remains throughout.

  5. Edward Harrison says

    Here is what I wrote in May – in line with what Marshall says about the Ostmark 1:1 exchange but very much focused on the lack of productivity in the east given unionized wage parity. The result was an increase in production in Eastern Europe.

    Can one-euro jobs, work programs, and other forms of stimulus change this? Not in any fundamental way. Until eastern German productivity reaches western levels there will always be a gap.:

    Kohl was adamant about bringing the two countries back together in a way that quickly brought the east up to the living standards in the west. Germany instituted a solidarity tax to pay for an upgrading of the infrastructure in the east, which soon became in many respects better than in the west. Furthermore, the economies were unified economically using the Deutsche Mark and a quick integration of eastern German workers into the unions and wage structures in the west. Initially, wages were lower in the east, which caused bitterness for workers there. But wages were quickly brought up to western levels.

    Nevertheless, the economic side of re-unification was a complete disaster. For purely political reasons, Helmut Kohl, then the German Chancellor, rebuffed the advice of his economic advisors and decided to unite East and West Germany at an exchange rate of one for one. This represented a significant over-valuation of the East German currency. Moreover, the privatization of eastern German state enterprises by the Treuhand was a boondoggle for the few to enrich themselves at the expense of the many as it was in Russia. And it led to massive speculation in eastern German real estate by companies with zero experience in property. The result was a property bubble and crash and lingering indebtedness in the German corporate sector.

    To make matters worse, Kohl also pushed through the now infamous east-west Lohnangleichung (wage parity) whereby eastern German worker wages quickly rose to the level in the west. The east was a heavily manufacturing-based economy. So wage parity meant a pricing out of eastern German labour, high unemployment there, and an eventual move of German manufacturing to central and Eastern Europe instead of to the former East Germany.

    https://pro.creditwritedowns.com/2010/05/the-soft-depression-in-germany-and-the-rise-of-euro-populism.html

    1. Marshall Auerback says

      I think that’s a very good and accurate account, Ed.

      1. Edward Harrison says

        Call me cynical but I would argue – as many did at the time – that Kohl was buying votes.

        It’s clear that the East Germans had no party allegiances and it was important for the ruling coalition to use their position in power to lock these voters into their column. The question was how to do so. The Lohnangleichung and Ostmark parity were cynical political attempts to buy votes, plain and simple. Angela Merkel’s rise – she is from the former DDR – owes to similar political motives.

        Ultimately it backfired because of the unemployment problem and the east has turned away from the CDU.

        1. Marshall Auerback says

          A politician buying votes?! Impossible! That never happens!

  6. Edward Harrison says

    This is from Wikipedia’s German entry of Hans-Werner Sinnof the German ifo Institut. It says:

    http://de.wikipedia.org/wiki/Hans-Werner_Sinn

    In 1991 together with his wife Gerlinde, he published a book “cold start” criticizing the reunification policy of the Kohl government, because instead of concentrating on the participation of the citizens of the former GDR in purchasing formerly state-owned assets, Kohl concentrated on a policy of rapid wage adjustment. And so they think the new states will be forced into a mass unemployment. This analysis was repeated by Sinn and his wife in an interim assessment of the economic unification of Germany in November 2009 under the title “The botched cold start.”

    Im 1991 zusammen mit seiner Frau Gerlinde veröffentlichten Buch Kaltstart kritisierte Sinn die Wiedervereinigungspolitik der Regierung Kohl, weil sie statt auf die Beteiligung der Bürger der ehemaligen DDR am ehemals volkseigenen Vermögen auf eine Politik der schnellen Lohnangleichung setzte und damit nach ihrer Meinung die neuen Bundesländer in eine Massenarbeitslosigkeit zwang. Diese Analyse wiederholten Sinn und seine Frau in einer Zwischenbilanz der wirtschaftlichen Vereinigung Deutschlands im November 2009 unter dem Titel “Der verpatzte Kaltstart”.

    This is exactly how I put it too in May. If you read that last quote. VERY undemocratic boondoggle via the Treuhand in handing out eastern Germany’s wealth to the well-connected. The whole thing was a travesty.

  7. Max says

    I suppose you could compare the performance of East Germany to the other former communist states that didn’t have stimulus.

    1. Edward Harrison says

      you could but that would be more problematic given the differing fiscal and monetary regimes.

    2. Marshall Auerback says

      Max,

      Good point. I suspect that the bulk of the fiscal resources that were
      deployed were directed to East Germany, but in aggregate that represented a very
      small part of the newly unified Germany. I suppose a rough analogy would
      be the way that Texas boomed during the oil booms of the 1970s, whilst the
      US in aggregate suffered.

      It would be interesting to isolate the impact of fiscal expenditure in the
      east and west, but I haven’t seen enough work that has done that.

      I don’t claim to be an expert on Germany, however, and Ed, in addition to
      being a master of the language of Goethe, does know the region very well, so
      I’m loathe to tangle too aggressively with him on that one. But I suspect
      that the preparation for European Monetary Union did impact (and impinge)
      on Germany’s conduct of fiscal policy and the Bundesbank, well, the
      Bundesbank is the Bundesbank and that never changed.

      In a message dated 7/3/2010 12:18:13 P.M. Mountain Daylight Time,
      writes:

      1. Edward Harrison says

        And you will notice I don’t tangle with Marshall on the basic need for
        stimulus. I was more concerned with the high labor costs as a source of the
        problem. My argument is that the stimulus just could not overcome this.

        Sent from my mobile phone
        twitter.com/edwardnh

        1. Marshall Auerback says

          The Scandinavians show how a high wage economy is possible. We don’t need
          a globalised race to the bottom. Seymour Melman has done some excellent
          work on this.

          In a message dated 7/3/2010 12:50:08 P.M. Mountain Daylight Time,
          writes:

          Edward Harrison wrote, in response to Marshall Auerback:

          And you will notice I don’t tangle with Marshall on the basic need for

          stimulus. I was more concerned with the high labor costs as a source of the

          problem. My argument is that the stimulus just could not overcome this.

          Sent from my mobile phone

          twitter.com/edwardnh

          Link to comment:
          https://pro.creditwritedowns.com/2010/07/lessons-learn-stimulus-jobs-programs-failed-eastern-germany.html#comment-60446620

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          1. Edward Harrison says

            Right, my mistake – I really meant the low labor productivity ie the
            relative labour costs in west versus east.
            —————————————-
            Edward Harrison
            http://twitter.com/edwardnh
            http://www.creditwritedowns.com

          2. Marshall Auerback says

            We agree. But it’s a good area to highlight as I do think that Germany has its own unification experience as the model. A classic fallacy of composition mistake, in my opinion, but that’s what is driving them. Now, it might be that the Germans recognise that this will create huge pain for a number of years in the euro zone, but that this is a price well worth paying if the Asian markets of China and India are the long term prizes that they can win, providing that their companies can compete.

  8. Gbgasser says

    Good article Ed but I want to make a few observations.

    Knowing that East Germanys production per capita is at less than 70% now needs to be held up against where it was in 1990. It was less than 40% then, maybe we are seeing as much improvement as can reasonably be expected. How do we know what we should be seeing from the stimulus?

    Losing millions of people to west Germany does not make it easier to improve economic output it makes it harder. Yes there are fewer people so the percapita seems like it would be better but if they needed those folks to do some productive work, the emigration is hurting overall production.

    I’m not sure, given where East Germany started 20 yrs ago that its reasonable to ask if what has been accomplished is enough. It sounds like the quality of life for most East germans has improved immensely, given the investments in public works. I think it might need to be asked though how any of this could have been achieved in this time WITHOUT the stimulus.

    You say;

    “At the same time, while stimulus can prevent a deflationary spiral, its supposed benefits are overplayed. I like to think it can be a boost in the short-term as the economy “re-calculates.” Longer-term, there are negative side effects. I can point to the former DDR as a prime example of why. We are in a longer-term deleveraging that is only going to be exacerbated by the debt stress associated with high debt levels and low nominal growth rates, something Bill Gross seems to understand. There is no way around this via stimulus”

    You are right that we are in a longer term deleveraging that was caused by PRIVATE SECTOR DEBT, not govt debt. I dont think it fair to say that Marshall and friends overplay the benefits of stimulus spending, I think its more accurate to say that those decrying are underplaying the amount of mismanagement the private sector created through their debt bubble. MMTers have never claimed magical results from stimulus. A return to our 2006-7 levels of economic activity from one round of stimulus was never promised, expected nor desired. Just like it took decades for the private debt levels to reach the point that tipped in ’07-’08 it will take time to get back to healthier levels of debt.

    As you no doubt understand now, when the private sector NEEDS to delever this much and exports cant make up the gap, the public sector going into “debt” is the ONLY place an economy can look.

    1. Edward Harrison says

      gbgasser, I think the differences for many of us have to do with tone and stress. Marshall and I largely agree with the chain of events (lower productivity and high unemployment due to the political calculations of reunification). However, there are substantive differences as well from some parties.For instance, I take issue with Bill Mitchell’s claims that “much more public infrastructure is needed in the East and more public jobs to alleviate the unacceptable levels of persistent unemployment.” I don’t agree at all. If anything, eastern Germany has had TOO MUCH infrastructure investment as evidenced by the idle airports and the demolition of stimulus-improved housing projects. Making claims that stimulus can overcome any obstacle are not credible and therefore only diminish from the likelihood that others not steeped in the economics will go in that direction.Your argument is more directionally correct: that stimulus has taken eastern Germans to 70% production per capita from 40%. The gap may eventually close. Meanwhile, the lower productivity levels have meant unemployment. Arguing that massive amounts more stimulus can prevent this overlooks facts I think the Spiegel article lays out well. It also disregards the very real political constraints. We have to remember that western Germans see the solidarity tax on their paychecks every month. They FEEL the tax in the same way they do the VAT which is ALWAYS shown in prices in Germany. I know for a fact that you can see the tax on your paycheck and this has a psychological impact. Again, it’s simply not credible to say “we need to spend more” even though people are already turning away in disgust.Of course, one could argue that since taxes don’t fund spending, the Germans could go the deficit spending approach to funding stimulus in eastern Germany. While that may be technically correct, it is politically naive.

      1. Gbgasser says

        I cant comment on any specific comments Bill has made regarding East Germany although I read his blog everyday ( I check yours out 4 times a week Ed …….. I know you were wondering ;-) ) I will say that its likely that Bill would concur about some of the current results of stimulus and his answer would simply be, porly placed stimulus is not effective but the answer is not NO stimulus its better directed stimulus.

        I know your Austrian roots lead you to counter that govt directed stimulus is always hampered by ineffectiveness and I would concur but I would also add that the private market has a poor track record as well of picking the best investments over time.
        To me its a human problem of knowing what people will want in the future which is a problem whether you are T Boone Pickens or
        Peter Orszag. What I wish more people would admit is that there is no economic reason to choose private investment over govt (in our current system….. obviously a complete command economy would not be good in most peoples view) the choices are all based on political preferences. Too much ink has been wasted, in my view, trying to make economic arguments for a purely privatized system. There is nothing magical about a decision made by an investment banker vs a politician. Bad investment bankers make bad decisions and bad politicians make bad decisions.

        1. Edward Harrison says

          I think we are on the same page directionally, gbgasser. I prefer some stimulus and the likelihood of malinvestment to no stimulus in this environment. In fact, I would have preferred a lot more stimulus in 2009 in the states. To me it is a choice of more aggregate demand or less i.e. collapse or a glide path.

          https://pro.creditwritedowns.com/2009/10/the-choice-is-between-increasing-or-decreasing-aggregate-demand.html

          I agree that the private sector can get it wrong (especially when interest rates are held artificially low – as they are right now, by the way). Too much IS wasted waiting for the ominpotent private sector to do the heavy lifting when it is not up to the task right now. That’s a matter of ideology, not economics.

      2. Gbgasser says

        “I think we are on the same page directionally, gbgasser.”

        I do too. I’ve really enjoyed your contributions at Naked Capitalism and watching you think through MMT. Its actually made me more convinced of its utility to see someone with Austrian background find such power in its analysis. I have no background in finance like you so to see someone who does, and worked under a certain paradigm for so long, take on some of his own views and reanalyze them is commendable. You are an example of a how a person should always view their perceptions
        “I think they are right…….. for now”. You’ve obviously found holes in the old stories about how finance/the economy works and looked to fill them. Your exchanges with Marshall show an intellectual curiosity and honesty that is missing from way too many people today in our toxic environment.

        “I would have preferred a lot more stimulus in 2009 in the states.”

        Me too. Teachers are valuable consumers and we need MORE not less of them.

        “I agree that the private sector can get it wrong (especially when interest rates are held artificially low – as they are right now, by the way)”

        Have you looked at Warren Moslers and Bill Mitchells parers which talk about keeping interest rates at zero perpetually?
        They seem to argue (and it makes sense to me) that monetary policy should be less of a factor and central banks could focus on more useful activities (like monitoring their fellow banks) besides meeting every so often and deciding whether to change the price of money this month.

        “Too much IS wasted waiting for the ominpotent private sector to do the heavy lifting when it is not up to the task right now
        That’s a matter of ideology, not economics.”

        Feels like you pulled those words right out of my gullet!!!!

  9. Perrone says

    Ed — I must be missing something. your central point regarding stimulus and job program spending directed to the former East Germany is that it “didn’t work.” but the chart you highlight on East Germany’s relative economic output since ’91 is basically a straight line up. so, yeah, East Germany still hasn’t fully caught up, but it sure as hell seems to have moved pretty impressively in the right direction. no?

    1. Edward Harrison says

      Yes, Perrone I think you are missing my point. I agree that time and investment has definitely been a help in moving the east up the productivity curve. It is not that stimulus ‘failed’ completely. Rather it is that stimulus can only do so much. It strikes me as false that the former DDR suffers because too little investment has been made.

  10. bernd says

    Hi Ed,

    You asked for potential other factors, that may have had an influence on the performance of East Germany(“If anyone has other thoughts, please supply them in the comments.”).
    Here are two:
    1. The primary export market, the USSR(accounting for approx. 40% of East German trade[http://www.country-data.com/cgi-bin/query/r-5103.html]) completely collapsing.

    2. A whole skillset/competitive advantage(supply chains from the GDR to the USSR, knowledge of language, personal contacts,…) suddenly(and I mean in less than a years time after German monetary union) becoming completely useless, with the USSR(later Russiaand teh rest of the GUS) descending into 15+ years of turmoil, croynism and the colapse of non-natural resource related enterprises.

    That´s an adverse shock to the economy, if I´ve ever seen one(think what the US colapsing virtually overnight would do to Chinas export sector…)

    In hindsight, it is always easier to know better, but very often the decisions made at the time they were made, with the information available are not nearly as ridiculous as they seem in hindsight.
    The economic gameplan behind the currency union(in connection with reunification of Germany) was for West German companies to provide the know how, and efficiency, taking over East German enterprises, whilst using their established suplly chains, contacts and language as well as cultural skills to help the USSR on its way of transition(Perestroika), retaining GDR-exports(expanding them) in the process, with financing provided by banks that, at the time were closly intertwined with industry.
    Political&personal realtionships between the heads of the (West) German government and the USSR(Gorbatchev) were excellent at the time.
    In summary, the general assumption at the time was, that the USSR would follow a gradual process of economic and political transition(in economic terms comparable to Chinas openig to the world economy), the logic behind the German currency union was based on this premisis.
    Whilst this may seem naif in hindsight, I do believe it is interesting to keep in mind the consensus of that time: which saw Gorbatchev as an inspired reformer and China as a totalitarian regime not keeping up with modern times.
    Whilst I can´t provide any specific data, I would assume that loosing ones main trade partner(40%) and relevant skillset of ones citizens is not helpful to the wellbeing of any economy.
    To reduce this to the factors of: “Time”, “Capital” and “Cost of labour” may be convenient but does not take into account the adverse shocks
    experienced.
    I very much doubt this example settles any argument pro or contra stimulous, in my humble opinion external factors are the key….

    1. Edward Harrison says

      Bernd, great extra tidbit on the collapse of the Soviet Union. But regarding time, cost of labour and capital, the question was about why stimulus hasn’t pulled the two halves even yet.

      I think the loss of export markets is better as an addition to why the collapse happened in the first place. I had been talking about labour competitiveness. But loss of export markets is certainly important. Thanks for pointing that out.

      1. bernd says

        Hi Ed,thanks for your reply. I do however believe you have missed the key points I was refering to: Your statement:”I think the loss of export markets is better as an addition to why the collapse happened in the first place.”Answer: Actually no, what the trade between the GDR and the USSR is concerned. The breakdown of bilateral trade between the USSR(its dissolution: December 31, 1991) and East-/Reunified Germany did not happen until well after the German currency union(“Wirtschafts-, Währungs und Sozialunion”, http://de.wikipedia.org/wiki/W%C3%A4hrungs-,_Wirtschafts-_und_Sozialunion ) was implemented(July,1,1990). Hence, with reference to trade with the USSR it can hardly be “an addition to why the collaps happend in the first place”.Your statement: “I had been talking about labour competitiveness. ” … was precisely the point I was trying to make, under the circumstances prevalent at the time of currency union, the expectation was for west german firms to use the expertise of their east german acquisitions to build on their market share within COMECON(especially the USSR), fusing existing supply contracts, contacts,… with western efficiency and capital. The sudden collapse of the Soviet Union, which was not expected, not even by the CIA, obviously derailed this plan. In hindsight, given the facts(collapse of the USSR) adjusting wages and prices 1:1 obviously seems like a less than perfect concept, the basic idea of being a provider of knowhow, machinery and direct investment however worked out just fine for the countries suppplying that other former communist state which took a different path(China). Taiwan, Hong Kong and Singapore,… have been doing quite well employing their connections. The point here being, the general perception at the time when the currency union was decided upon, was that the USSR would undergo a slow and gradual process of transformation, in which case the currency conversion East to West Germany, would well have been justified.What would have been the alternative? Tell a third of potential voters: “We got it wrong, history did not pan out along the lines we evisioned, we´ll have to cut your wages in half”?So, yes in hindsight, the conversion level of currencies was a major mistake. But bear in might that you are getting into the territory of major what ifs here: What if the USSR would have gradually adapted post 1990? , What if the Tianmen movement in China had been successful(Would there be deficits in the Us?,…), What if the August coup against Gorbatchev had been successful?Whilst historical “what if”- questions are always enteraining complete regime changes usually do(and should) constitute a breaking point in any analysis.Whilst I do agree with your basic point, that stimulous is not necessarly the best solution, I do believe you have chosen a particularily bad example to prove Marshall Auerback wrong.

        1. Marshall Auerback says

          Frankly, I don’t think there are any examples which “prove” that fiscal expansion doesn’t work, but all depends on context.

          For example, I know that there are people now arguing that Ireland, Latvia, and Estonia show the benefits of “recovery” which come with fiscal austerity.

          I recognise that reland does have some data points with a recovery complexion. It will be heralded by the Austerians as a case study of how the Cold Plunge technique works. Therefore a careful read of why Ireland may be turning back up despite sharp and prolonged fiscal austerity needs to be undertaken,preferably integrating a financial balances approach. My understanding is we have a combination of trade turning and some domestic retail sales activity, but I need to look through all the evidence Tyler has put together. 

           I suspect we will end up finding if the fiscal policy is used mostly to contain the banking contagion, and the policy of “infernal devaluation” does lead to wage deflation sufficient to turn the trade in a small open economy (and even Keynes, remember, in the GT allows for this relative price adjustment mechanism in his chapter 19 hair pulling), then it is possible for one country like Ireland to get to some sort of recovery profile, but surely no one in their right mind can believe the eurozone as a whole, or even a large bloc of countries in the eurozone, can make this turn en masse. 

          I think this will be an important case study that we need to be prepared to address. Latvia may be another. And I would invite some of you to also consider engaging with the findings of the Goldman piece I mentioned recently, where 44 episodes of sharp fiscal retrenchment accompanied shortly thereafter by a return to economic growth in the OECD since 1973 were analyzed, and it was business investment, not trade, that led the charge.

        2. Edward Harrison says

          How is your statement different than mine regarding the collapse of
          employment in the former DDR? The point is that after the early 1990s, the
          east suffered from high unemployment. The question us how to deal with that
          high unemployment. Both Marshall AND I agree that stimulus and works
          programs were necessary. Some might disagree but this is where her and I
          agree. I am not disproving anything he had said.

          Where I am focussed is that were can’t act as if stimulus is some magic
          bullet that will make all problems go away. The unemployment gap has not
          closed making this a perfect example of the limits of stimulus.

          Sent from my mobile phone
          twitter.com/edwardnh

          1. Marshall Auerback says

            Agree with Ed, who I think was making the point about how the fiscal
            stimulus was directed (i.e way too much infrastructure).

            But I think Bernd makes a very good point. The collapse of the old East
            Germany’s export sector was a huge additional drag. Add to the fact that,
            contrary to many assertions to the contrary, the fiscal stimulus in Germany
            overall was pretty insubstantial (as a percentage of GDP) from 1992 onward,
            and you’ve got an excellent explanation of why the old East Germany and West
            Germany provide truth to Kipling’s old dictum, “East is east and west is
            west, And never the twain shall meet.”

            Hopefully, that won’t prove to be the case here, although the way Merkel’s
            government is proceeding, we might get them meeting at the bottom, sadly.

            In a message dated 7/4/2010 6:37:27 P.M. Mountain Daylight Time,
            writes:

            Edward Harrison wrote, in response to bernd:

            How is your statement different than mine regarding the collapse of

            employment in the former DDR? The point is that after the early 1990s, the

            east suffered from high unemployment. The question us how to deal with that

            high unemployment. Both Marshall AND I agree that stimulus and works

            programs were necessary. Some might disagree but this is where her and I

            agree. I am not disproving anything he had said.

            Where I am focussed is that were can’t act as if stimulus is some magic

            bullet that will make all problems go away. The unemployment gap has not

            closed making this a perfect example of the limits of stimulus.

            Sent from my mobile phone

            twitter.com/edwardnh

            Link to comment:
            https://pro.creditwritedowns.com/2010/07/lessons-learn-stimulus-jobs-programs-failed-eastern-germany.html#comment-60573806

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          2. Edward Harrison says

            Bernd is right about the Soviets. That was a missing piece in the narrative.
            who knows where eastern Germany would be now.

            Sent from my mobile phone
            twitter.com/edwardnh

          3. Marshall Auerback says

            Agreed

        3. Edward Harrison says

          I should also point out that I have made a lot of statements in the past in
          support of both stimulus and works programs including in this comment
          thread.

          Sent from my mobile phone
          twitter.com/edwardnh

        4. Traderscrucible says

          Hey guys – I read CW everyday.

          I think this is a good example of the potential for malinvestment with ANY type of spending. For some reason, we all like to point out the malinvestment of govt as being somehow unique or on a scale that is worse than the private sector.

          But we only have to look at things like the housing bubble and the internet bubble to realize that the private sector is if anything worse than the public sector. There is a bigger bubble still that nobody here has mentioned: The oil and gas infrastructure build out over the last century.

          At some point within the next two decades, all of this oil infrastructure will look like a horrible malinvestment. This has been on a scale that dwarfs any housing or stimulus that we’re mentioning here because it was a public private joint venture that provided real benefits to real people for almost a century – much like the housing and internet bubbles did for a decade and 5 years respectively.

          As long as there are humans making the investment, there is going to be malinvestment. And what seems like entirely reasonable investments at the time – think adding lead to gasoline – seems in retrospect to have been beyond foolish. The idea is to minimize bad investment – and this article is part of the discussion on what we can do to make it a bit better.

          So, in the specific case of East Germany, we have an example of the limits of stimulus and government spending. Ed has pointed out how even with all of this spending, Easter Germany is still much like the U.S South in the 1980’s. So what is the difference?

          I’ll contend that change happens very slowly – at the pace of the old guard dying off and new people taking their place with slightly different ways of doing things. Changes on this scale takes decades and decades to accomplish. I remember talking with an older woman who burned her bra in the 60’s, and her realization in the 1980s that they were not abject failures, but wildlly successful because they had moved the needle about women’s rights just a bit. This stuff doesn’t happen overnight, and no amount of money is going to change that.

          So with the U.S. south, we had 60 years of spending, and only in the last 15 years or so has the needle started to really move. They are still incredibly poor when compared to the north – and while the GNP of the states is growing faster than those in the north, they aren’t going to overtake the north for at least 70 years at current rates – and assuming that current relative rates of growth will continue for that long is foolish.

          Given the fact that Poland was right there and also moving in the same direction, with cheaper wages, the improvements were always going to be extremely difficult to make because there was a cheaper alternative very close by for probably much the same goods and services.

          Then I’ll argue that China and the former Asian tigers have hit upon a very good model – if you’re going to spend, spend it in public private partnerships that build industry and business, not infrastructure and social programs. What China has done was spend a few trillion dollars making their private sector competitive by keeping the exchange rate very favorable and sheltering them from international competition until the industries (or even individual plants) were large enough to stand on their own. New businesses are enormously difficult to launch – even with good products and positive cash flow, many businesses fail. So by providing an atmosphere where it is just a bit easier to get over the hump, these counties spent the same money but got hugely better results.

          BTW. I run a newsletter that has 2,300 subscribers – much like Rob P. I am also a MMT guy -but I focus on currencies and credit. We should spend another 1.5T tomorrow and get this world moving again- and I think at least 50% of it should be a payroll tax holiday. I get to talk to

  11. Edward Harrison says

    Marshall,

    I have to confess to being a lot more pro-stimulus than this article sounds. More than anything, this article is about the limits of stimulus more than its failure.

    The point is that the Germans DID apply a lot of stimulus and eastern German productivity levels DID improve dramatically from their low points in the early 1990s. But, the productivity gap between east and west has NOT closed anymore than the unemployment gap.

    My conclusion from this is not that stimulus is ‘bad’ or that it ‘doesn’t work’ but that it failed to close the two important gaps between east and west over a rather long period of twenty years.

    Further, regarding the stimulus debates today, this is very much relevant in regards to Spain-German productivity gaps and the US unemployment rate. Some pundits act as if stimulus is a magic bullet back to prosperity. I say it is not – and that this is a case which demonstrates why.

    I’ll leave it at that for now rather than move into the political realm where most of this debate lies. But I will say two things:

    First, those pro-stimulus advocates who act like full-tilt stimulus no matter how applied are doing more harm than good. I would like to see some jobs programs or a payroll tax cut. I would like to see some government-sponsored industry investment. But somehow I sense those arguing for stimulus full-stop are doing more harm than good. I haven’t been able to put my finger on it, but even I find the arguments too partisan and too defensive mostly.

    Second, Barack Obama did much to discredit stimulus. You know I feel this way. The stimulus was too small and ill-targeted. The massive financial sector bailouts juxtaposed to the non-existent jobs agenda made stimulus seem like a boondoggle to pay off special interests. And the laughable claims about the likely efficacy of stimulus in reducing the unemployment rate make new claims for stimulus less credible.

    I said this would happen in February 2009. I said Obama gets one shot and that’s it:

    https://pro.creditwritedowns.com/2009/06/obama-takes-middle-road-on-stimulus-and-taxes-that-leads-nowhere.html

    In his defense, so did Paul Krugman. But my argument now has been that the debate must move away from ‘stimulus’ or deficits toward jobs. Terms like ‘deficit terrorist’ and even ‘austerian’ only create division. Instead, what Obama should be doing is a full court press on J-O-B-S and drop any reference to stimulus or deficits at all. This downturn is about the household sector: debt and employment.

    Of course, Obama’s not going to do any of that and that’s why the deficit hawks will get what they want. Personally, I’m thoroughly disgusted at this point. I’ve thrown in the towel long ago. I feel as if special interests are so in ensconced in the political process and Republicans so focussed on making Obama a failure that I don’t know if the U.S. government can do anything of value.

  12. Andy Goodell says

    The “economic output as % of western germany” graph on the right looks pretty positive to me. I guess my expectations of how a former communist area should be performing are well below everyone else’s? To use the author’s analogy of the US South, Reconstruction ended in 1877. Maybe the end of Jim Crow in the 60s is a better landmark, but still… Reunification was only 20 years ago. 70% of productivity seems over par from my perspective.

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