Germany – economic statistics – Developments in Individual Countries
More than a year after political unification divergences in economic performance between eastern and western Germany remain striking. The western German economy has continued to benefit from a boom which continued stronger than expected into the first half of 1991 (1), but wage earners and consumers are now feeling the effects of higher direct and indirect taxes introduced to help finance reconstruction in the east. In eastern Germany, the steep decline in industrial production appears to have ended in the spring, though signs of an upturn have so far been restricted to certain sectors, notably those dependent on direct state expenditure or subsidy.
The unification process has pushed up the rate of inflation: in eastern Germany mainly through the progressive elimination of subsidies, but also reflecting strong pressure for wage convergence, which is itself having a damaging effect on eastern German competitiveness and employment prospects; in western Germany through strong demand which has supported high wage settlements and an upward creep in underlying inflation. Despite the rapid growth in the demand for labour in western Germany, unemployment has edged up since April, halting the downward trend that had been apparent since 1988. This reflects the increasing integration of western and eastern labour markets; as much as half of the increase in employment in western Germany between 1990 and 1991 has been accounted for by eastern German workers who have either moved or commute across the former border.
The first six months after political union were characterised by intense effort to design policies to deal with different problems arising from unification, and to assess the quantity of financial help to be provided and the degree to which this could be safely financed by increased public borrowing. The main measures were in place by spring 1991 and signs of improvement are beginning to appear. The Treuhandanstalt, after a slow start and reorganisation, has been privatising over 300 entities a month and has made increasing efforts to raise the degree of foreign participation. However, the firms that remain with the Treuhand may be increasingly more difficult to sell.
Surveys show that investment by German investors in eastern Germany is set to increase considerably following a period in which hopes of an early construction boom had been disappointed. Treuhand privatisations invariably carry a contractual commitment by the purchaser to investment in the acquired company and this, along with the direct effect of public infrastructure investment programmes, is beginning to affect construction activity. It is notable, however, that apart from small private business the only factor making for greater optimism in eastern Germany recently – improved export orders – is also dependent to a considerable degree on state support in the form of federal government credit guarantees for exports to the Soviet Union.
The financial cost of unification has so far been largely associated with supporting living standards in eastern Germany above the level that the existing capital stock can support. This has resulted in a rapid rise in the general government deficit, which may turn out at over 3 1/2 per cent of (all-German) GNP in 1991. Some of the support for eastern Germany is off-budget – guarantees for export credits to the Soviet Union and for liquidity credits to Treuhand firms, as well as borrowing on its own account by the Treuhand (which is technically not part of the public sector). The outlook for the general government financial balance is for a gradual reduction of net borrowing as a proportion of GNP over the next three years.
The decline in national saving resulting from increased public transfer payments and the simultaneous rise in the rate of investment has shifted the current account of the balance of payments from substantial surplus to moderate deficit in 1991. Although the shift was large, almost 6 per cent of GNP, the resulting deficit has been financed relatively easily. So far short-term capital inflows rather than reduced long-term capital exports have been the counterpart of the changed current-account position. Further substantial increases in the deficit are unlikely as the western German economy slows and eastern German output recovers.
Overall, the outlook is for a considerable cooling-off in the western German economy, with pressure in the labour market being reduced from the demand side, as well as the dampening effect of high unemployment in the east. Current indications are that the Bundesbank will keep short-term interest rates high – at about current levels – for some time. The size and timing of indirect tax increases means that reported inflation figures will decline unevenly and only slowly but a firm non-accommodative stance of monetary policy should add pressure for lower settlements in the coming wage round. The timing of the direct tax increase – a 7 1/2 per cent income tax surcharge running for twelve months from 1 July 1991 – is an additional source of uncertainty in the outlook, as the response of consumers to such a temporary increase is hard to predict, particularly so soon after considerable once-for-all gains in disposable income as a result of the 1990 Tax Reform.
Western German GNP continued to grow strongly into the first half of 1991, reaching a level 4 1/2 per cent above a year earlier. Different methods of seasonal adjustment provide different indications about the extent of the slowdown during the first half, but industrial production, which had grown almost 6 per cent over the twelve months to January 1991, was at the same level six months later in July; the level of production in August and September taken together was barely above that of the same period in 1990. Other indicators also show signs of a sharp slowdown. The volume of retail sales fell sharply in August and September to levels similar to a year earlier. The Ifo survey of production expectations in manufacturing industry has been declining since the beginning of the year, and in some recent months has shown more firms expecting a decline than expecting an increase. The strong growth in domestic orders, which offset falling export orders during 1990, has ceased, without a compensating recovery in foreign orders. The general business climate indicator fell during the first six months of 1991, levelled off for a time and fell further in September.
Employment growth in western Germany, though diminishing, was still strong in the first half of 1991; total employment grew by over 55 000 per month in the year to January 1991, and by just under 40 000 per month in the following seven months. Unemployment fell continuously until March, but has since picked up a little, reaching 6.4 per cent of the dependent labour force in September. The total labour force in the first half of the year was about 1 1/4 per cent higher than a year earlier.
Most components of demand in western Germany grew strongly in the first half of 1991, although, as noted above, interpretation is made difficult by seasonal adjustment problems. Total fixed investment grew particularly strongly, to a level 8 per cent higher than a year earlier; within this total, machinery and equipment investment showed an increase of nearly 13 per cent. Private consumption was also vigorous, rising almost 4 per cent between the first halves of 1990 and 1991. By contrast, public consumption fell slightly over the same period, reflecting a temporary transfer of civil servants to the new Lander. Western German exports, which on a national accounts basis include deliveries to eastern Germany, were a major source of demand growth in both 1990 and 1991 as increasing transfers financed strong demand from eastern Germany.
Consumer-price inflation remained quite low up to the second quarter of 1991, with food prices barely rising between October 1990 and March 1991. But underlying inflation – excluding energy and seasonal food – which had fallen slightly in the second half of 1990, has since begun to creep upwards. In July a range of indirect taxes were increased, which pushed the twelve-month increase in consumer prices to 4.4 per cent. Although the year-on-year increase had fallen back to 3 1/2 per cent by October, this was a result of the pattern of energy price increases in 1990, and of low import prices, and not because of any deceleration of domestic costs. Producer prices have remained more subdued than consumer prices, with a level in the third quarter 2.3 per cent above a year earlier. Wages have accelerated: monthly earnings in industry, after rising about 5 per cent in the year to the fourth quarter of 1990, accelerated to over 6 per cent year-on-year by the second quarter of 1991. So far this has had only a modest effect on unit wage cost increases – which rose from 2.4 per cent to 2.8 per cent over the same period. But increases in employers’ social security contributions boosted the rate of increase in unit labour costs for the economy as a whole to 4 per cent in the year to the second quarter.
In eastern Germany, consumer prices have accelerated strongly, increasing by almost 18 per cent in the twelve months to July. Following an actual fall as the border was opened, the process of subsidy-withdrawal has pushed up the average consumer-price level during 1991. The principal areas of subsidy were rented accomodation, energy and public transport. While major rent adjustments were due to take place in October 1991 (eventually, rents are due to rise by 300 to 400 per cent), energy costs in July were already 150 per cent higher than a year earlier. In general, free trade between eastern and western Germany means that prices of easily-transported goods should be at similar levels, adjusted for taxes and subsidies, in the two areas. Indeed, output prices of manufactured goods have changed very little over the past twelve months, leaving those for clothing and shoes 30 per cent, and for household goods nearly 20 per cent, below pre-unification levels.
Despite high average price increases, real wages in eastern Germany have continued to increase rapidly. In industry, nominal monthly earnings by the third quarter of 1991 were as much as 60 per cent above their level immediately after monetary union. Many of these increases stem from settlements which specify continuing high rates of wage growth in the future, often involving parity with western standard wage levels by 1994. At the same time, with output falling sharply during the first year of economic union and slow adjustment of employment, productivity plunged, increasing the unprofitability of large segments of Treuhand-controlled firms and making them dependent on one form of subsidy or another to prevent mass closures and layoffs.
Output in eastern Germany appears now to have stabilised, however. While monthly movements in industrial production are still erratic, the steady downward trend ended in the spring. On the other hand, no sustained upward trend is yet apparent, and the improvement in export orders largely reflects orders from the Soviet Union which take up official (“Hermes”) export credit guarantees announced early in the year. The construction industry is, however, beginning to turn round, as order inflows rose in the summer to a level twice that of the first quarter and 60 per cent above the last quarter of 1990.
The current account of the balance of payments for Germany as a whole may well have stabilised too. The deficit in the first half of 1991 reached DM 22 billion ($13.5 billion), of which more than DM 10 billion was accounted for by Gulf war contributions. This compares with a surplus of DM 47 billion in the first half of 1990 and DM 78 billion for 1990 as a whole. But the seasonally-adjusted trade balance, which had moved into deficit between May and July, was in surplus again in August and September. The value of imports, which rose steeply[Tabular Data Omitted] up to the first quarter, grew very little in the second quarter before surging again in the third quarter. Exports fell in the second quarter, but grew by more than imports in the third.
The 1992 federal budget, debated in the Bundestag in September, confirmed a lower estimated deficit for 1991 than previously expected. More buoyant revenues and some underspending in eastern Germany may result in an overall public sector deficit of little more than DM 100 billion – some 3 1/2 per cent of (all-German) GNP – for 1991, compared with some earlier estimates of over DM 130 billion. The federal financial plan for the years to 1995 provides for a decline in the federal deficit from around DM 60 billion in 1991 to DM 25 billion by 1995. General government includes, in addition to the federal government, the Lander and local governments – whose joint expenditure roughly matches that of central government – the social security system, the Unity Fund and certain other special funds. The Unity Fund was established to provide finance to eastern German state and local government beyond what they can borrow on their own account, and its interest payments are the joint liability of the federal government and the western German Lander.
In 1992 the federal government is likely to achieve a considerable reduction in its own share of the public sector deficit – the financial plan calls for a reduction of DM 17 billion – while on the other hand the social security surplus is likely to shrink. When the eastern German economy begins to recover, its call on public funds should diminish; however, spending delayed from 1991 may push up expenditure in 1992 and prevent the overall general government balance from improving. The deficit for 1991 would have been much larger had it not been for a series of measures announced in March, including the income tax surcharge and indirect tax increases. Some further increases in taxes and public sector charges are due in January 1992. It is envisaged in addition (and incorporated in the projections here) that the rate of value added tax will be increased at the beginning of 1993, probably from 14 to 15 per cent. Reductions in subsidies in western Germany are also an important element of the financial plan, though the impact on actual subsidy expenditure of the announced cuts of DM 10 billion for 1992 may be considerably less, since the cuts are measured against “no policy change” levels, rather than against actual 1990 expenditure.
For much of the year monetary growth was below the initial 4 to 6 per cent target, which itself was lowered in July to a range of 3 to 5 per cent, but the annualised increase over the target’s base period accelerated to 4 1/2 per cent in September. However, the Bundesbank is clearly not relying on such indicators alone in deciding its interest rate policy, in particular as asset-holding behaviour in eastern Germany is not yet clear and since the monetary “overhang” that resulted from currency union in 1990 was ignored when the 1991 monetary target was first set – implying considerable base-drift.
The Bundesbank, on several recent occasions, has warned about the inflationary dangers of high wage settlements, and short-term market rates drifted up through the summer, the three month Frankfurt inter-bank rate reaching 9.3 per cent in August, anticipating some tightening. The increases in the discount and Lombard rates in August (to 7 1/2 per cent and 9 1/4 per cent, respectively) were designed to emphasise the commitment to lowering inflation. Following initial falls after the latest 1/4-point rise in the Lombard rate, short-term rates have since drifted back up to August levels, while long-term bond rates have tended to decline.
The uncertainty over prospects for the public-sector deficit and the pending 1992 wage bargaining round are likely to keep both short- and long-term interest rates from declining significantly before the middle of 1992. Once clear signs emerge that the budget deficit and inflation are under control, long-term rates should begin a steady if gradual decline; the Bundesbank is likely to allow short rates to fall also once a deceleration of underlying inflation seems well established.
Current wage developments, combined with cyclical weakness in western German productivity growth, are, however, unlikely to allow any deceleration in overall unit labour costs before mid-1992. Initially, disinflation is expected to come from some squeeze on profit margins as demand pressure eases. By 1993, the increase in the GNP deflator, adjusted for indirect tax and subsidy changes, may be around 3 1/2 per cent, down from an estimated 4 1/4 per cent in 1991. The slowdown in underlying consumer-price inflation, starting from a lower rate, is likely to be modest. The recorded figures may not show a sustained reduction as the expected VAT increase in 1993 will add three quarters of a point or more to the index of consumer prices.
A deterioration of international cost competitiveness is projected, but growth of external demand for western German goods and services should improve next year and strengthen a little further in 1993. Capacity use is falling from its recent peaks, enabling exporters who had been diverting production to the domestic and eastern German markets to meet increased foreign orders. But with financial flows to eastern Germany not expected to rise much further, the contribution of eastern German demand to total demand growth in the western German economy will greatly diminish. The increase in “exports” to eastern Germany between the first halves of 1990 and 1991 amounted to about 4 per cent of (western German) GNP; from 1992 onwards, increases of more than 1/4 to 1/2 of a percentage point per annum are unlikely.
Slowing private consumption and low public consumption growth complete the picture of declining final demand growth in 1991 and 1992. Import growth can therefore be expected to fall considerably from its recent high rates, and GNP to grow at rates below potential throughout the projection period. Western German potential growth itself, though sustained by the high levels of investment in recent years, is likely to slow a little in response to slackening immigration and migration from eastern Germany. Despite this, the western German unemployment rate is likely to increase gradually, and the damping influence of the large excess supply of labour in the new Lander on western wage inflation should remain.
In eastern Germany growing activity in the construction sector should induce a wider recovery, reinforced as new plant and machinery investment comes on stream. It is likely, however, that the upturn will be patchy, across regions, sectors and firms. The total amount of unused and underutilised labour may continue to increase into 1992, and will fall only gradually thereafter. Recorded unemployment has already been reduced by early retirement and training measures as well as employment-preservation schemes, though some of these schemes compete with and reduce the demand for private-sector suppliers.
While eastern German output is expected to recover, the new Lander are likely to be increasing importers of capital. Supply and demand in western Germany should move into better balance and, under the assumption of constant nominal exchange rates, the terms of trade for Germany as a whole are projected to improve; hence, while the all-German current account may remain in deficit, this is likely to diminish.
(1.) Problems with the seasonal adjustment procedure used by
the Bundesbank (whose figures are the basis for the analysis
here) have, in recent years, resulted in an exaggeration of
the strength of the economy in the first half of the year and
an underestimation of activity in the second half – mainly in
construction investment. For this reason greater attention
should be paid to year-on-year and annual growth rates than
to the semi-annual pattern in the accompanying projections.
Table : Western and eastern Germany: key projections
western Germany eastern all Germany
1991 1992 1993 1991 1992 1991 1992
GNP 3.2 1.8 2.5 -20 13 2 2 1/2
Consumer prices 3.4 4.0 4.0 12 12
Unemployment(b) 4.6 5.0 5.1 20 20 8 1/4 8 1/2
(a) Figures for eastern Germany are not Secretariat projections; they are based on
the most recent independent institute projections, supplemented by other
information. (b) Eastern German and all-German figures include an estimate for effective
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