Economic Efficiency and Political Constraints - The Dilemma of Privatization in Eastern Germany


Term Paper (Advanced seminar), 2005
10 Pages, Grade: A-

Excerpt

Economic Efficiency and Political Constraints - The Dilemma of Privatization in Eastern Germany

Introduction

More than 14 years after German unification, the transformation process integrating the former centrally planned economy of the German Democratic Republic (GDR) into the market economy of the Federal Republic of Germany (BRD) is far from over. Unemployment rates in Eastern Germany are on average more than twice as high than in the West and GNI per capita reaches only €17,528 compared to €27,671 in the West (Deutscher Bundestag 2004, p. 153).

The debate over the reasons for this crass difference in economic performance is still fierce. While it is clear that it is not easy to erase the marks of 40 years of communist rule on the functioning and structure of the East German economy, citizens increasingly blame the architects of unification for having mismanaged unification and not having delivered the promised “flourishing landscapes”. Increasingly, this critique focuses on the privatization of state enterprises that accompanied the transformation process of the East German economy. Under the bleak circumstances of the East German economy, it is no coincidence that privatization and a quest for re-nationalization of certain “key industries” appear on the platforms of parties like the extreme right NPD and the socialist PDS1. Both parties have consequently gained substantial support during recent elections.

Given this extreme critique and growing dissatisfaction with the largely privatized economy of Eastern Germany, it seems opportune to re-evaluate the process of privatization that accompanied German unification. The first part of this paper will provide a general introduction into the economic problems of German unification. Part two introduces privatization as a principal means of transformation and the following three parts describe the actual privatization process in Germany. The final part assesses the work of the Treuhand - the government agency entrusted with privatization - and concludes.

German Unification and Economic Transformation

On 9 November 1989 the Berlin Wall fell. This dramatic event brought on the demise of the GDR paving the way for German unification. Convinced to have only a small window of opportunity to forge unification, Helmut Kohl’s government disdained the cautious warnings by leading economists and lawyers, and rushed into organizing immediate unification with the objective to incorporate the former GDR into the West German model ofsoziale Marktwirtschaftas quickly as possible. This process entailed the merger of two very diverse countries - politically, economically and socio-culturally. Considering that there had never been any similar event in history to draw experience from, this was an enormous challenge indeed.

While the BRD had experienced one of the most impressive economic miracles after the World War II and became the world’s third largest economy, the GDR economy was not merely as successful. Although being the star economy of the communist world - the GDR was COMECON’s major producer of machinery and chemical products - the performance of the GDR economy lagged far behind western market economies. The reasons for this difference in economic performance between the two Germanys were manifold.

Firstly, as typical for a centrally planned socialist economy, the great majority of productive capacity belonged to the state. Large, state owned enterprises(Volkseigene Betriebe),often grouped into huge industrial conglomerates(Kombinate),made up 80.7 percent of total assets. Cooperative property accounted for another 14.7 percent in March 1990. Private property merely amounted to 4.7 percent of economic resources and was confined to small-scale businesses, restaurants, and craft shops. Employment was consequently almost entirely in the hand of the state leaving only about 2 percent of the workforce independently employed (Merkl 1994, p. 200).

Also, the structure of the GDR economy differed largely from its western counterpart. Employment was heavily concentrated in sectors and branches that had actually been declining in the West. The production was skewed towards agriculture, energy, mining and manufacturing, which together accounted for 47 percent of employment in the GDR (37 percent in the BRD) (Lange and Pugh 1998, p. 32). As shown in table 1 agriculture, forestry and fishery, energy and mining as well as textiles and clothing employed almost 18 percent of the GDR’s workforce in contrast to 7 percent in West Germany. Further differences appeared in the service and trade sector which, by Western standards, was rather underdeveloped in the GDR.

Table 1 Sectoral Employment Structure in Selected Industries in East and West Germany, 1989/90

Abbildung in dieser Leseprobe nicht enthalten

Note: The numbers do not add up as statistics tend to be inconsistent between different authors.

Source: Mueller 1998, p. 149, Lange and Pugh 1998, p. 63-66.

The industry as a whole suffered immense weaknesses which had developed over the years of its existence under the socialist system. Production processes in the Kombinate were integrated vertically and horizontally, resulting in a quite unproductive under-specialization. The resulting low productivity was further accentuated by the almost complete lack of incentives for management and workforce. Also, except for integration into the inefficient economic markets of COMECON, East German firms had never been exposed to real competition. Consequently, firms suffered under largely outdated capital stocks and often entertained huge inventories of raw material and intermediate goods. Overall by some accounts productivity in Eastern Germany reached merely 28.2 percent of the level of Western Germany in 1987 (Beintema and van Ark 1993).

Given these crass differences between the economies of Eastern and Western Germany, unification and the transfer of the entire institutional framework of Western Germany to the territory of the GDR together with the German Currency Union equaled an immense economic shock. While this shock provided Eastern Germany with an institutional framework of a market economy and a stable currency2 (processes which in other East European countries were problematic) it also created some distinct problems for the last step of transformation - the real adjustment of the economy to a market economy (Siebert, 1993, pp. 25-26). The restructuring of the large and inefficient enterprises became the key economic task and difficulty of economic transformation. This process was inextricably linked to privatization.

Privatization

Privatization lied at the core of the transformation and was explicitly mentioned in the Unification Treaty, which demanded that that economic activity on the territory of the former GDR ought to occur primarily in the private sector and on the basis of competition. The reasons for this focus on privatization were twofold.

Firstly, it is widely acknowledged that private ownership of the means of production fosters efficiency and increases the dynamics of an economy. By creating incentives and allowing competition, private ownership fosters the efficient allocation of scarce resources and leads to more efficient production processes directed to serve consumer demand (Smith 1994, p. 475). In short, private ownership lies at the heart of any market economy and is a prime requisite for its success.

Secondly, the break up of the state monopoly on production is believed to pave the way for the emergence of new economic groups, chiefly among which a class of entrepreneurs. This lies the foundation for political plurality and therefore contributes to the long-term stability of a new democracy. Moreover, the new class of entrepreneurs can form the basis for a form of Schumpeterian “creative destruction” of the old economic structures and lead to a dynamic economy.

In order to achieve a widely distributed ownership of firms among the population - the theoretical owner of the GDRVolkseigentum- a particular system of privatization was contemplated. Under the system of mass privatization (or voucher privatization) vouchers would be distributed to eligible citizens. These vouchers could then be used to bid on shares of formerVolkseigene Betriebe. According to the value this type of auction would determine, shares would then be distributed to the citizens. However, very soon it became clear that the great majority of state owned firms actually did not have a positive market value. Originally estimated to be worth over DM 400 billion by the last communist GDR government of Modrow, the value of the state property soon had to be revised and downgraded radically (Fucci 1995, p. 10).

It became clear, therefore, that as an integral part of the transformation process, privatization needed not only provide firms with private owners but also with the necessary capital for their restructuring as well as new technology and a more efficient management (Siebert 1993, p. 88). Only this way would the efficiency features of a market economy unfold. However, as both capital and sufficient knowledge and experience about a market economy were not available in the east, these factors depended highly on inward investment. Therefore, the government stood before a political dilemma of having to choose between two different policy goals. Either it could proceed with an equitable distribution of shares at the cost of renouncing on a potential inflow of new capital and knowledge. Or it could choose to privatize by a more efficient but less inclusive method in order to foster a “real” adjustment of the GDR economy.

Believing that only a real restructuring of the economy would create new and sustainable jobs in the long term, the government opted for the second alternative, and decided to sell the assets to knowledgeable and liquid private investors. These private investors were supposed to foster the sustainability of the companies bringing in new management, the knowledge of markets and advanced technologies and the necessary capital.

In order to assess the knowledge and financial liquidity of potential buyers, the privatization of former GDR state property was decided to take the form of informal bargaining with private investors. This task was undertaken by theTreuhandanstalt(THA), the government trust agency which administered the great majority of former GDR state property.

The Treuhandanstalt

The Trust Agency for the People’s Property was founded on 1 March 1990 by the last communist government of the GDR under Hans Modrow. At that point its task was actually more to “rescue parts of the old economic system than to transform the economy” by privatizing it (Volkhart 1993, p. 142). For this rescue mission, almost the entireVolksvermoegenof the GDR was transferred to the THA, making it the “world’s largest holding company”. Its property consisted of more than 300 industrial conglomerates, 8,000 public enterprises, 30,000 small shops, restaurants, hotels and service firms, 2.3 million ha of arable land, 1.9 million ha of forest, and the assets of former GDR parties, mass organizations and the army. Together this accounted for nearly 90 percent of the GDR’s productive capacity, 57 percent of the land area and up to half its labor force. (Lange and Pugh 1998, p. 57).

On 17 June 1990, the newly elected democratic government of Lothar de Maizère amended the Treuhand Act to emphasize the THA’s mandate for restructuring the economy of the GDR through the privatization of its assets. This decision was preceded by a fierce debate led by the former Minister of Economic Affairs in the Modrow government, Christa Luft, who feared that an emphasis on privatization would result in a sell out of the GDR Volksvermoegen to the detriment of the Eastern German population (Kruesselberg 1994, pp. 287-288). Political pressures deriving from this debate led to an inclusion of a broad set of goals into the Treuhand Act. Besides the primary task of privatization, the mandate of the THA therefore included aspects from the entire spectrum of transition, including responsibility for fostering structural change in the economy and financing partial restructuring of potentially viable companies. Of course, the major goal in this respect was to secure jobs and to create new ones. This multitude of potentially conflicting objectives led to a continued debate which endured over the entire life span of the THA. Nevertheless, the THA began working on its new tasks with the best intentions on 1 July 1990.

Phase 1 - Rapid privatization

The first operation undertaken by the THA was to convert its entire portfolio into GmbHs (limited liability companies) or AGs (joint stock companies) according to West German law. However, before that, firms actually had to be created by breaking up former conglomerates. In fact, as noted by Hax (1992, p. 145), in the GDR economy “there were no autonomous firms but only administrative units in a hierarchically organized and centrally planned production system.” Consequently, the THA separated these conglomerates to create smaller, more specialized entities which closer resembled the structures of firms Western investors might be interested in.

When preparing the sale of these newly created firms, the THA encountered major disputes concerning the property rights of assets in its portfolio. While a clear legal definition of property rights had been introduced with the adoption of the legal system of the BRD, problems arose over who actually owned the assets in the first place (Siebert 1991, p. 19). First the Nazi and later the SED governments had widely practiced expropriation as a means to favor the “national interest”. Given that many years had passed since the expropriations and few official documents existed, the quest for legitimate owners was very problematic (Merkel 1994, pp. 200-201). Still, despite these obvious difficulties, more and more property right claims reached the courts, 1.5 million by mid 1991. These claims significantly slowed down the privatization activities of the THA as privatizations in which the assets were subject to restitution claims had to be suspended. In 1992, relief was finally provided by the Property Law, which allowed compensation instead of restitution in cases where investment was threatened by ownership uncertainty (Lange and Pugh 1998, p. 66). The THA could therefore proceed with privatization while the claims were settled in court.

Another problem which the THA had to face from the beginning was the great variance in business prospects of the firms in its portfolio. In order to estimate the potential viability of the firms and to decide how to proceed with each single unit, they were classified into six broad groupings. These categories ranged from firms viable enough to be privatized, to firms that could be privatized after some restructuring and finally firms that needed to be liquidated. It was representative for the GDR economy and rather disappointing that only 2 percent of firms were classified as profitable and ready for privatization, while about 70 percent were thought to be able to survive only after massive restructuring. The remaining 28 percent were believed not to have any chances of surviving in a market economy and thus should have been liquidated (Dyck and Wruck 1999, p. 47).

Of course, this classification had immense social and political implications for Eastern Germany as restructuring and liquidation necessarily involved a massive reduction in employment. These circumstances were the major reason for the choice of selling firms through a process of informal bargaining. The Treuhand did not try to maximize its revenues but rather attempted to choose buyers according to their ability to sustain the company in the long run and save jobs. Therefore, the THA was disposed to give heavy discounts on the selling price in exchange for viable business plans, demonstrated management ability, knowledge of the market and promises in the form of employment and investment guarantees on the part of the investors. Consequently, the THA lowered sales prices, sometimes to the symbolical amount of 1 DM. In other cases employment subsidies and investment incentives in terms of tax breaks and depreciation allowances actually surpassed the sales price (Balasubramanyam 1994, p. 75).

Despite these problems, the focus of the first year of THA activity was on quick sales. By June 1991 about 30,000 small businesses had been privatized. These small to medium scale businesses had mostly been sold to Easterners, in about 2600 cases through management buy outs (MBO). Moreover, 7,000 privatization contracts for parts of larger enterprises had been signed and more than 1,000 liquidations were initialized. At the same time, job guarantees for more than 1 million workers and investment guarantees in the height of DM 120 billion had been obtained (Dyck and Wruck 1999, pp. 46-49). While these guarantees highlighted the THA’s concern for saving jobs, the speed of the first phase of privatization was evidence of the focus on restructuring by private investors - a strategy the THA clearly favored. According to the THA rationale, the quicker privatization would take place, the quicker and the more efficiently firms could be restructured to create sustainable jobs in the long term.

Phase 2 - Active restructuring

After the first phase of privatization had quite successfully been handled the constant decline of the East German economy increased political pressures on the THA. East German GDP deteriorated, falling from DM 160 billion in 1989 to DM 105 billion in 1992 (Domdey 1998, p. 47). The hardest hit was the traded goods sector, which suddenly was exposed to western competition and whose competitiveness was gravely reduced by the Currency Union and increasing wages (Lange and Pugh 1998, p. 64). At the same time, unemployment rates increased rapidly. Though part of this unemployment was merely a consequence of uncovering the hidden unemployment of the GDR economy3, its rise from an official rate of zero percent in 1989 to 15 percent in 1992 (31% if one includes early retirement and work on government-sponsored interim jobs) was inevitably bound to create tensions (Dyck and Wruck 1999, p. 53). Although the THA was an independent agency, it was still part of the government and could not entirely be shielded from the arising political pressures.

[...]


1 See party platforms of the PDS and the NPD: [http://www.sozialisten.de/download/grundsatzdokumente_partei/parteiprogramm2003.pdf] [http://www.npd.de/npd_dokumente/NPD_Programm.pdf]

2 I will at this point refrain from elaborating on the actual effects of transferring an outdated and inefficient regulatory and welfare state system together with an extremely strong currency onto the territory of a relatively underdeveloped economy. However, the tremendous effects of these political choices are visible throughout the entire transformation process of Eastern Germany and greatly affect the success of its economy up to the present day.

3 Actually, unemployment in the GDR was already quite high under communist rule but remained hidden. As everybody was entitled to a job, workers were kept also in non-productive activities.

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Details

Title
Economic Efficiency and Political Constraints - The Dilemma of Privatization in Eastern Germany
College
Johns Hopkins University  (School of Advanced International Studies (SAIS))
Course
West European Political Economies
Grade
A-
Author
Year
2005
Pages
10
Catalog Number
V39207
ISBN (eBook)
9783638380485
ISBN (Book)
9783656246251
File size
485 KB
Language
English
Notes
Single spaced. Keywords: Privatization, Privatisierung, DDR, Treuhand, Treuhandanstalt, Germany, Unification, Political Science, Economics
Tags
Economic, Efficiency, Political, Constraints, Dilemma, Privatization, Eastern, Germany, West, European, Economies
Quote paper
Patrick Avato (Author), 2005, Economic Efficiency and Political Constraints - The Dilemma of Privatization in Eastern Germany, Munich, GRIN Verlag, https://www.grin.com/document/39207

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