[Overseas view]The costs of unification

Germany marked an important event last year, 17 years after unification. The German Statistical Office revealed last month that for the first time since unification, Germany’s public budgets (the central, regional and local government budgets, plus social security funds) had a foundational surplus. A surplus had been recorded once before, in the year 2000, but only thanks to huge special revenues from the auction of cell phone licenses.
In 2006 there was still a public deficit of 36.9 billion euros ($56 billion), or 1.6 percent of Germany’s gross domestic product, compared to a tiny surplus of 200 million euros last year. Korea, usually a keen observer of all events related to Germany’s unification, largely missed this event, understandably, due to its focus on domestic policy changes and the inauguration of a new administration. But it might be worth considering what lessons Germany’s financial policy after unification holds for Korea.
Public deficits in Germany were not solely due to unification. Starting in the 1970s, when the welfare state was aggressively extended, West Germany began to amass public debt. In the early 1980s, that huge debt helped Helmut Kohl and his Christian Democrats win office on a promise to put a stop to debt-financed policy. However, this was easier said than done. It took another six years before the goal of a central government budget surplus almost came true. That was in 1989. Then unification changed everything.
The original assessment of the cost of unification was very modest. Though the deplorable state of East Germany’s economy became visible after its border opened, most politicians and economic experts hoped that unification would largely be self-financed through revenue from privatization. The last communist prime minister of East Germany, Hans Modrow, estimated in early 1990 that the East German collective assets (volkseigenes Vermoegen) amounted to 1.6 trillion Ostmarks. Even with a realistic exchange rate for the East German mark, this would have been a handy treasure to pay the costs of unification. But the collective assets proved to be a phantom. Nobody knew that better than the people of East Germany, who left for the West. Starting in November 1989, when the borders opened, more than 600,000 people left East Germany in six months, increasing the burden on the economy.
This was particularly true because both young and flexible Germans, as well as the highly educated people who still had a chance in West Germany’s job market, left.
Even still, the costs of unification were considered modest. In May 1990, West Germany established the German Unity Fund with 115 billion Deutschmarks (around $80 billion then). However, the Treuhand organization, which was responsible for the privatization of East Germany’s companies, alone accumulated a debt of 205 billion Deutschmarks. That figure did not include any of the infrastructure investment or social transfers necessary to stop the mass migration from East to West.
From the point of view of political and monetary stability, the economic unification was a spectacular success ― the unification went smoothly and the German Deutschmark remained stable, with only modest inflationary pressure, though 16 million additional users of the Deutschmark had to be accommodated overnight. However, it came at an economic cost.
From 1993 onward, Germany was in a permanent economic crisis, with unemployment at historic levels and public debt rapidly accumulating. Also, the European monetary system, due to the (understandable, but ultimately costly) unwillingness of other European states to adjust to the German high interest policy, finally crashed. It is especially ironic that Germany, which had insisted on a public deficit limit of 3 percent for governments in the European Monetary Union since 1999, was one of the first nations to violate the rule, damaging its role as a European anchor of economic stability.
Germany’s social system clearly needed to be reformed, but the government of Helmut Kohl in 1998 finally was ousted in part due to minor corrections it made to the country’s generous social security benefits.
It took four more years for the first Social Democratic government of Gerhard Schroeder to seriously tackle social security reform.
And, though Schroeder himself failed to benefit from the reforms (he lost his job in 2005), the combination of a peak in the business cycle plus the results of the reform finally brought Germany’s public budgets back to the black.
One of the political prices for those reforms was probably the permanent establishment of a left-wing radical new party formed by former communists in East Germany plus a collection of West German disaffected left-wing social democrats disgruntled by social security reform. Former Economic and Finance Minister Oskar Lafontaine is the most prominent member.
Korea just saw the inauguration of an administration vowing to pursue the policy of a lean government based on pragmatic realism. Both are needed for unification. The sweet poison of budget deficits to finance goodies is quite addictive. In any case, unification will bring about a need for massive public investment. So, lean government ― complemented by lean and competitive company structures ― is the best preparation for unification.
Germany learned this the hard way. Nevertheless, given the goal of unification, even this price was well worth paying. A well-prepared government in Korea cannot avoid the costs of unification, but it can help reduce them and manage them in an orderly manner.

*The writer, the representative of the Hanns Seidel Foundation in Korea through 2007, is writing a book about North Korea’s economy.

by Bernhard Seliger