Why east Germany is slow to change

November 05, 2009, Financial Times

(Gastbeitrag von Klaus F. Zimmermann)

Twenty years ago, on November 9 1989, the fall of the Berlin Wall marked the decisive step towards German reunification – and eventually Europe’s reintegration. Back then, hopes were high for rapid economic integration of the former communist east and the capitalist west.

Double-digit growth rates seemed to herald a dynamic process. Soon enough, though, soberness set in – and it became apparent real integration would be arduous. Industrial production in the former East Germany – which fell by about two-thirds immediately after unification – has only recently exceeded its level in 1989.

Even now, eastern Germany’s gross domestic product – measured on a per capita basis – is only about 70 per cent of the western level. Yet, progress has been made in terms of the region’s competitiveness. As measured by unit labour costs, the east pulled even with Germany’s western states in the late 1990s. Since then, manufacturing companies in the east have become about 15 per cent more cost-competitive than their western counterparts.

The flipside has been a depressed employment level. While manufacturing has experienced strong growth in production volumes and productivity, it has been essentially a jobless recovery from the mid-1990s to the middle of this decade. East German unemployment exceeds 12 per cent – nearly double the western level – though in recent years unemployment has fallen more in the east than in the west.

The most interesting – and overlooked – insight of east Germany’s transformation is that its difficulty in catching up with the west ultimately proves to be not so much a reflection of its communist past than of its rural, low-density population structure. Simply put, economic value increases with population density. The more companies swap ideas and the closer they co-operate, the better it is for productivity – and incomes.

This holds true not just in Germany, but across the board. Companies locate headquarters in densely populated areas because they offer a better habitat for decision-making in disciplines ranging from sales and marketing to research and development and overall strategy. It is in these regions that highly skilled service-sector jobs, such as software developers, finance managers, advertising specialists, business consultants and trade facilitators, are created.

This analysis suggests the real distinction is not so much between “east” and “west” as between low-density and high-density regions, no matter where they are in Germany.

For example, the densely populated, highly networked city of Hamburg generated a per capita GDP of €51,000 in 2008 – which made it Germany’s top economic performer. Likewise, the economically most successful large state, Bavaria, also offering plenty of networking, generated €36,000 per person. In contrast, the economically weakest of west Germany’s largest länder, Schleswig-Holstein, has low population density and produced a GDP of €26,000. That is roughly in line with the €21,000-€23,000 average generated by the large eastern states.

On average, Germany’s eastern states have 153 people per square kilometre, compared with 264 in the west. Schleswig-Holstein’s population density, at 179 people per square kilometer, is only slightly above the east German level – as is its GDP. While it is hard to measure precisely, differences in population density between east and west Germany might explain about half of the regions’ GDP growth differentials.

What, then, is the way forward for east Germany? The answer is that it must develop a more sharply defined regional comparative advantage.

National economies are in constant flux, with opportunities to be spotted all the time – and new sectors emerging as powerful forces. The key question is: what can east Germany do better than west Germany?

For urban areas to find a specialism is a lesson that applies far beyond Germany’s borders. The rust belt around Pittsburgh in the US, for example, has long worked on its economic comeback through innovation in industries such as advanced manufacturing and information technology. Even in a well-functioning market economy, it takes decades for reinvention and retooling to succeed. Detroit is an area where the agony continues, despite the city’s knowing for decades that it must do things differently. In Germany itself, the Ruhr area – 30 years after its coal and steel industries went into decline – is another example of the long timelines needed for economic transformation. This isn’t an east-west story, but one of weak versus strong regions, which is found the world over.

In another 20 years, with communism shrinking into the background, it may be easier to see east Germany’s challenge for what it really is: an unfavourable demographic structure cast centuries ago. Communism or no communism, it is tough to change things in a fundamental and lasting fashion, as discovered even in the US.

That country, though, offers inspiration. Twenty years ago, as the Berlin Wall was coming down, the American South was another under-achieving region, lagging behind the north in income, productivity and education.

Since then, Atlanta, Birmingham, Charlotte, Dallas and Houston have experienced boom times and are a destination of choice for foreign companies setting up in the US. If it can happen there, it can happen in the former East Germany, too.

The writer is president at DIW Berlin, the German Institute for Economic Research, and director of IZA, the Institute for the Study of Labor, Bonn

Reprinted with permission.