Euro project has repeated the bad aspects of German reunification

It was utterly predictable that Germany’s political class would (ab)use the festivities of Unification Day to construct some bizarre justification for more Eurozone bailouts, and a further transfer of power to Brussels. This time, the official line was that those fighting for a European superstate today were somehow the true heirs of those who had brought down the Berlin Wall. German reunification was reinterpreted to be somehow a consequence of prior European integration, in order to fabricate a moral obligation to do whatever it takes to keep the Euro project afloat. It was yet another variation of the same old line, which goes: ‘Taxpayer, you cannot even imagine how much you owe to the European project, and you should be ashamed of yourself for complaining about the cost. Be grateful that we have built this wonderful European Union for you; paying your dues now is the very least you can do.’

What a waste, because Unification Day would be a good occasion to reflect about why exactly the Euro project has turned out the way it has. Twenty-two years ago, Europe’s political leaders were given the opportunity to see what happens when two structurally very different economies are forced into a monetary union. Germany’s currency union of 1990 is to the Euro what Romneycare is to Obamacare.

The premature replacement of the Ostmark by the Westmark, at the wholly artificial exchange rate of 1:1, produced a sharp increase in East German real wages. This would not have been a big problem if it had not been for the fact that at the same time, rigid West German labour law was also imposed upon the East. The Eastern economy could have coped with one of these rigidities, but not with both simultaneously. With rigid labour markets and a free-floating exchange rate, the Ostmark would have devalued against the Westmark. Within a currency union and free labour markets, East German wages would have adjusted to East German productivity levels. With both paths closed, unemployment in the East soared to over 20%, and stayed there.

East and West did not really converge, but they did not completely drift apart either. The inner-German currency union was premature, but at least two of the features that define an optimal monetary area were recognisable: there was some degree of labour market mobility, and some grudging acquiescence to huge fiscal transfers. East-West labour migration was never remotely enough to make unemployment rates converge, but people did move from Saxony to neighbouring Bavaria and from Saxony-Anhalt to neighbouring Lower Saxony in search of work. Meanwhile, a large interregional transfer bureaucracy was established, which remains highly active to this day. It was probably the least efficient way to bring the East into shape, but at least some of it fructified.

Now let’s compare this to what happened in the Eurozone over the past ten years. In the countries with traditionally high trade deficits, the introduction of the Euro was also followed by a sharp increase in wages and prices, exacerbating their trade deficits even more. The mechanisms which led to this were very different from the German case, but the outcome was not.

In pre-Euro times, this situation would have been balanced through a devaluation of their currencies vis-à-vis the Mark, the Schilling and the Gulden. This adjustment mechanism has gone. Countries with free-ish labour markets could cope with this situation by adjusting wages and prices internally, but the notoriously rigid labour markets of the Mediterranean do not allow this option either. They are thus trapped in a predicament not unlike the one East Germany found itself in during the 1990s, but without the crutches that made East Germany’s situation endurable. Intra-European labour migration has increased, but language barriers remain significant, and will for the foreseeable future. Meanwhile, there is no public acceptance for a transfer union at the European level. How could there be, if it was never really accepted even within countries? Intra-German fiscal transfers created a lot of mutual resentment and unnecessary hostility between East and West. I remember the emergence of lots of East-West jokes in the 1990s, the punchline always being about the Wall being re-erected, and both sides being happy about it.[1] Only jokes, yes, but not necessarily a laughing matter.

To sum up: European monetary union repeated the bad aspects of Germany’s monetary union, whilst being unable to repeat the good aspects. However, Unification Day is also a reminder that people do not always put up with the fantasy projects of power-hungry elites.

[1] Here’s one for the record:

Three Germans, one from the East, one from the Saarland region, and one from the Pfalz region, are walking through an enchanted forest. They encounter a fairy, who promises to fulfil the dearest wish of each of them. The Easterner says:

‘I want the GDR back, with Wall and everything.’

The fairy waves her magic wand, and his wish is granted. Then the Saarländer says:

‘I want the Saarland to be part of France again.’

The fairy waves her magic wand, and his wish is granted. She then asks the Pfälzer:

‘And what is your wish?’

‘I would like to have a beer.’

‘A beer? Is that all? I can make any wish come true!’

‘“I know, but you have already fulfilled my two dearest wishes.’

Dr Kristian Niemietz is the IEA's Head of Political Economy. Kristian studied Economics at the Humboldt Universität zu Berlin and the Universidad de Salamanca, graduating in 2007 as Diplom-Volkswirt (≈MSc in Economics). During his studies, he interned at the Central Bank of Bolivia (2004), the National Statistics Office of Paraguay (2005), and at the IEA (2006). He also studied Political Economy at King's College London, graduating in 2013 with a PhD. Kristian previously worked as a Research Fellow at the Berlin-based Institute for Free Enterprise (IUF), and taught Economics at King's College London. He is the author of the books "Socialism: The Failed Idea That Never Dies" (2019), "Universal Healthcare Without The NHS" (2016), "Redefining The Poverty Debate" (2012) and "A New Understanding of Poverty" (2011).

1 thought on “Euro project has repeated the bad aspects of German reunification”

  1. Posted 08/10/2012 at 16:29 | Permalink

    I like the joke. But, in political reality, the ‘deal’ between President Mitterand of France and Chancellor Kohl of Germany was asymmetrical. France agreed to German re-unification if Germany would agree to drop the deutschmark and join the single currency. But while everyone recognised that it was at least conceivable that the euro would not last (indeed many of us predicted exactly that), it is surely quite inconceivable that German re-unification could be reversed. Thus, not for the first time, it may be that the Germans will end up having got the best of the deal.

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