This month marks the 25th anniversary of the reunification of
Germany. Integrating two vastly different economies was a hugely
risky venture. West Germany was a global powerhouse while East
Germany was an economic weakling, wracked by poor productivity and
unprepared for the introduction of a market system.
One of the main decisions facing West German politicians was the
choice of official exchange rate between the West German
Deutschmark (DM) and the East German Ost-Mark.
On the face of it the decision was straightforward. The DM was
one of the world's strongest currencies, an anchor of stability
and a symbol of West Germany's post-war economic miracle. The
Ost-Mark was the currency of a failed state and an enfeebled
economy. The market reached its own verdict and in the winter of
1989-90 the Ost-Mark was trading at seven to one DM.
This exchange rate destroyed East Germans' spending power in
Western shops and set up huge incentives for the citizens of East
Germany to seek work in the West. With the opening of the border,
tens of thousands migrated westwards. The shift in population
undermined East Germany's economy and placed huge pressure on
West Germany's welfare system.
This set the scene for an epic battle between politicians and
policymakers over the choice of an official exchange rate for the
The policymakers, in the form of West Germany's Bundesbank,
wanted the Ost-Mark to trade close to a market exchange rate. It
argued that a weak Ost-Mark was would help offset the effects of
poor productivity and would help East German industry cope with
reunification. The Bundesbank warned that an artificially high
exchange rate would force up costs in the East and inflict more
damage on its economy.
West Germany's Chancellor, Helmut Kohl, disagreed. He wanted
a one to one exchange rate believing it would provide stability,
preserve the spending power of East Germans and stem the flow of
migrants. With elections looming in the East, a one to one exchange
rate would also go down well with the new citizens of the Federal
Chancellor Kohl brushed aside the warnings of the Bundesbank and
in the summer of 1990 the DM was introduced in East Germany with
wages and savings converted on a one to one basis. East
Germans' deployed their new spending power to go on a massive
spending spree in the West.
On the economics, the Bundesbank was proved right. A one to one
exchange rate added to the woes of a chronically weak economy
struggling with foreign competition and the introduction of
markets. Many East German businesses went bankrupt, unable to
afford a dramatic rise in wage and pension costs. By the mid-90s
East German industrial output had fallen by almost 30% from 1988
The choice of exchange rate made it harder for East
Germany's economy to catch up with the West. 25 years later,
unemployment in the East is twice as high as elsewhere. And the
eastern states are considerably poorer – a West German is
twice as likely to drive a BMW while an East German is twice as
likely to drive a Skoda.
Yet the decision on the exchange rate was about politics, not
economics, and in these terms it was a success. Reunification has
worked. Today the two Germanys are a single nation and the dominant
economic and political power in Europe. A generous exchange rate
avoided the destruction of the spending power and savings of East
Germans and made them feel equal citizens in the newly united
Sound economics is not always good politics. In a democracy, it
is politicians and people, not policymakers and officials, who make
the decisions. Major policy decisions cannot be reduced to an
economic calculation; countries are not like businesses, seeking to
make optimal financial decisions. Politics trumps economics.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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