Time horizons of transformation: lessons from the German unification for the eurozone

The harmonisation of national economies inside the eurozone is essentially a clash of time horizons – the future might be bright, but the transformation process in hard-hit countries is painful, and unfair. What lessons should we draw from the historical example of German reunification?

A worker outside a closed shop in Athens. Demotix/Panayiotis Tzamaros. All rights reserved.A worker outside a closed shop in Athens. Demotix/Panayiotis Tzamaros. All rights reserved.

All southern euro member states are forced by the euro crisis to fundamentally transform their economies and societies. In order to become aware of the challenges associated with transformation, it makes sense to recognise the implicit time horizons they imply.

Since transformative change of the economic and the political system (Blanchard et al. 1991) involves institutions and people, their success depends on a complex interplay between them. The basic problem of transformations consists in the fact that it implies different time horizons. First, institutions change faster than peoples’ attitudes. This carries the danger of overstretching their patience. And second, peoples’ expectations concerning the success of a transformation unfold in a shorter time horizon than its yields emerge. “Restructuring will necessarily take time.” (Blanchard et al. 1991: 35) The incongruence of the two time horizons makes disappointment likely to appear, hence processes of transformation might fail or at least have to pass through a ”valley of tears”, as Ralf Dahrendorf puts it. Consequently, managing transformations is about making different time horizons compatible.

In the aftermath of 1989, a rich fund of comparative transformation research arose (Przeworski 1991; Woo, Parker, Sachs 1997; Elster, Offe, Preuss 1998; Beyer, Wielgohs, Wiesenthal 2001). But so far it has hardly been deployed for debating and understanding the current problems within the eurozone. This is a pity, because the transitions of the former centrally planned economies provide a valuable lesson for coping with the problems of the common currency. I’ll concentrate on the transition from the former GDR into the new Länder and on Greece. But, mutatis mutandis, these conditions apply to other EU members as well.

The German precedent

At the end of the eighties, the German Democratic Republic (GDR) - as well as all other members of the COMECON - saw themselves at the end of a long process of economic downturn and political troubles. The post-Stalinist rhetoric of feeding the people's hopes with promises of future prosperity no longer worked, prospects of improving one's situation were poor, expectations of prosperity, spurred by comparisons with the affluent West, were high but permanently disappointed, efforts for more political participation and individual freedom were frustrated.

There were different motives and expectations which caused the all in all peaceful uprisings against the old elites. But they had one thing in common, namely to establish a new institutional order as a precondition for economic improvement and political liberalization. In the German case, the transformation consisted of taking over the complete set of West German institutions. The Deutsche Mark provided the institutional frame for the reorganization of the GDR into a capitalist market economy and its population saw it as the vehicle towards Western standards of consumption. 

By adopting the DM the FGR and the GDR were integrated in a single currency area, leading to a spectacular welfare gap between West and East. Literally overnight, enterprises in the former GDR new Länder saw themselves exposed to far superior competitors. The consequences were dramatic: abundant bankruptcies, fast-growing social problems, individual mobility from East to West and social transfers from West to East.

The Greek problem

Several southern euromembers (and in particular Greece) show some remarkable similarities with the German case. At the end of the first decade of the twenty-first century, Greece too finds itself in an economic downturn, both in absolute terms as well as compared with the core members of the EU. Individual promotion prospects are poor, especially for young people. The country suffers from an overwhelming majority of incompetent and predominantly corrupt old elites.

However doubtful the circumstances of the introduction of the euro (in 1999 and 2002), it integrated Greece into a common currency area, with all the 'classical' consequences (Mundell 1961): Greece is exposed to superior competitors in the core-EU countries without the protection of a currency exchange mechanism. In addition to the single currency area, the free movement of workers redefines the political space for mobility. In this respect the institutional constellation in Greece resembles the situation in Germany after unification.

It's all about the differences…

But there are also remarkable differences, the most important being that in contrast with the GDR, the poor economic performance of Greece remained hidden until the beginning of the international financial crisis. In 1999 the euro was introduced as an accounting currency, and in 2002 as banknotes and coins. With the common currency all relatively weak euro members forfeited the protection of the currency exchange mechanism. They were hardly able to cope with the competition of EU-core members, thus permanently producing balance of trade deficits. The consequences of this fact nevertheless remained hidden by the import of cheap money, flowing in either via transnationally operating banks or via growing public debts. The constant inflow of cheap money spurred rising levels of consumption which by far exceeded the economic performance of the southern euro members in real terms. In other words, they consumed much more than they produced. As a result, there was a totally different starting point for the transformation with fundamental consequences for its course.

Where did money and goods come from? In the first decade of the monetary union creditors assessed the credit worthiness of all euro member states as roughly the same. Greece, Italy, Spain, Portugal were able to borrow money in almost the same conditions as Sweden, Finland, Austria and Germany. For about ten years the interest rates of national bonds in the whole eurozone narrowed, whether it was because creditors - just like many political actors at the start of the common currency - expected economic convergence in real terms -  or whether, because nobody took the no-bailout clause seriously, i.e. creditors assumed that economically thriving member states would act as guarantors for their less performing counterparts. In retrospect: this was a giant failure of the financial markets (Vobruba 2012). 

Be it as it may. In any case, several euro countries developed high deficits, partly in the form of sovereign debt, partly as private debt - at least partly caused by recycled benefits of the core EU members' permanent export surpluses. Exploding state debts directly led to public refinancing problems, and private debts spurred a dynamic of real estate inflation. Between 1995 and 2007, the prices of homes almost quintupled in Ireland, and were multiplied by three in Spain. As these price bubbles later burst, private bank credits became irrecoverable, banks faced the danger of bankruptcy and - for they were esteemed as “system relevant” - had to be bailed out by their respective states. Hence, in a roundabout way, private debts ended up accelerating the explosion of states' deficits.

At this point several vicious circles commenced. Rising credit costs and downgraded credit ratings led to an increasing need for refinancing. Austerity measures of all kinds led to shrinking economies, thus to increasing public debt/GDP-ratios, even if public deficits in absolute terms decrease.

Problematic transformation

Just like in the GDR, there is a strong case for transformation of remarkable parts of the Greek institutional setting. But there are also decisive differences between these two transformations as well.

First, the inclusion of the GDR as new Länder within enlarged Germany resulted in a total replacement of most East German institutions; in Greece, in contrast, only partial - though fundamental - reforms are on the agenda. Second, in the case of the GDR, from its very beginning, the extent and radical nature of the transformation was clear, whilst in Greece this is an open question, hence subject to controversial debate - where should the transformation happen and how should it go? And finally, the underlying question: which motives drive these two transformations?

At least at its start, the transformation of the GDR enjoyed broad support. In contrast, before the international financial crisis emerged, in all the now troubled euro member states there hardly existed any politically relevant interests to engage in any substantial change. This is nothing but the consequence of the fact that, for a decade, the underperformance of these countries' economies was concealed by capital imports.

Over the course of the eurocrisis debate, the difference between the interests rate (for ten year loans) in Germany and the other euro members became an oft-used indicator for economic convergence and divergence within the eurozone. This is important if we want to understand how (potential) creditors think. People’s situation and expectations depend on a somehow similar indicator: people’s living conditions might be grasped by relating purchasing power parities per capita (PPP) of Germany with respective data in other euro member states. By doing this, the following picture for 2009 appears: 

 Country

 Germany

 Ireland

 Spain

 Italy

 Greece

 Portugal

 PPP (pc)

 36.960

 33.280

 31.630

 31.330

 28.440

 22.870

 Ratio with  Germany

 1:1

 1.11:1

 1.17:1

 1.18:1

 1.30:1

 1.62:1

These rates are in sharp contrast with the ratio between material living standards in the FRG and the GDR in the last years of the GDR. Taking the notorious unreliability of GDR-data into account, the welfare gap between FRG and GDR in 1989 is estimated to be more than 2:1. (Bofinger 1990: 18, 19)

These data reveal the following: with the exception of Portugal, the welfare gap between Germany and several lower productive Euro-member states was relatively small, whilst the ratio between western and eastern Germany at the beginning of the German monetary union was huge. And what is more, this is a situation within the eurozone after a period of catching up and (presumably) rising expectations, whilst in the German case it came at the end of a long decline in living standards and a growing welfare gap. 

What are the consequences? In both cases a crisis was the catalyst for transformation. But in the one case, there was a visible welfare gap - hence strikingly different living conditions, whilst in the other case the differences in economic performance were hidden. The starting points of both transformations are different, they were differently perceived and lead to totally different attitudes towards the transformation process. As these differences have a crucial impact on the transformations themselves, it is worth having a closer look at them.

The valley of tears

Importing cheap money led to a mismatch between the monetary and the material realms of distribution. Consequently, the core problem of political management in the eurocrisis is how to re-adapt domestic demand in monetary terms to supply in real terms. Granted that a sudden expansion of the economic performance is out of reach, such a re-adaptation can’t take place without renunciations either by domestic consumers or by foreign creditors. Hence, the eurocrisis spurs social conflicts around a simple question: whose group's claims will be answered, and whose will be rejected? Who will have to bear the costs of this re-adaptation? Practical answers to this question emerge in complex conflicts within and between the members of the eurozone.

By summarizing transformation research after the fall of the iron curtain, one can state that relieving the economic system from non-economic functions is a precondition for improving its productivity. This means addressing complex problems like the following: if public positions can be bought by elites, people are forced to buy administrative decisions. The fact that a handful of families dominate the economy, both locally and nationwide, as well as the political system, blocks careers and results in an adverse selection of top echelons. But in the first instance, liberating the state economy from non-vital functions means no longer using state enterprises as comprehensive socio-political institutions for their employees – resulting in layoffs, pay cuts and reduced safety nets for state employees. It goes without saying that any kind of liberation of the economic system from socio-political functions causes social conflicts and calls for compensation. This in a nutshell is the systematic reason why societal transformations need to be supported by social policy (Vobruba 1991). 

Gaining wide political support for transformation means narrowing the gap between the time horizons of institutional chance and the peoples’ time horizons, by at least partially serving their interests. In other words: transformation becomes endangered as soon as the Dahrendorf's “valley of tears” lasts longer than the period between democratic elections. But social security enables people to wait for the yields of the transformation.

Conclusion

To summarize:

A. The transformation of the GDR had the advantage of starting from a situation of massive collective dissatisfaction both with the economy and the political system. In Greece as well as in all other endangered euro countries there is no comparable dissatisfaction, hence no motive to give transformation any credibility by deferring one’s own interest.

B. In the new German Länder, the transformation was supported by collectively optimistic expectations. Though this optimism might have been partially unrealistic, for a period it contributed to the widening of the time horizon of the people's expectations, thus providing political room for manoeuver. In Greece and elsewhere, transformation starts with nothing but disappointment - causing a precarious incongruence between the people’s time horizon and the time horizon of institutional change.

C. In the new German Länder, opposition against transformation existed, but it was de facto powerless, for within entire unified Germany the losers of transformation always remained a minority. Hence “democracy’s time constraints” (Linz 1998) were suspended. But “democracy is a system in which parties lose elections.” (Przeworski 1991: 10): in contrast to the new German Länder, in Greece and elsewhere, the electorates have the potential of voting out transformation-oriented governments, thereupon effectively disturbing the transformation. The sheer existence of technocratic governments (like Mario Monti’s in Italy) can be seen as an implicit acknowledgement of – and protection against - this fact. Effective democratic veto power might be desirable from a normative democratic point of view, but it can delay or even jeopardize transformation processes.

D. German unification was dominated by a strong historical commitment to fully integrate the former GDR and let the population access western consumer standards. Extending the system of social security of the FRG to the new Länder created an inner German transfer union and meant buying time for transformation, for it equipped people with the ability to wait for the yields of the transformation. Thus the extension of the system of social security across the whole area of the common German currency represented a crucial contribution to the success of this transformation.

Austerity policies in Greece and elsewhere have had exactly the opposite effect. In practice, import surpluses, financed by the import of cheap money, raised the living standards there and caused a sort of transfer union - though an implicit transfer union based on the creditors’ illusion of repayment. And it is exactly this transfer of wealth that is now being painfully terminated. An explicit transfer union will come - but it takes time. Consequently, the present situation is that the gap between the time horizon of institutional change and of popular expectations widens. In addition to all the other differences between a single currency in unified Germany and the European Union, this makes the transformation process in the weaker parts of the eurozone even more complicated.

 

Read on 

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