Transition   Privatization   

Privatization of East Germany:

by Jan S. Prybyla  

by Sarah Corrie

by Michal Arian

   The Price of German Unification

by Jan S. Prybyla  

"With a view to corporate takeover, Volkswagen AG sent a Herr Heuss to Zwickau to find out how the Trabants (relatively cheap East German cars) were made there. He emerged shocked from the huge plant, babbling “My God. The Trabant operation was value-subtracting: valuable material, labor, and capital inputs went in at one end; shabby Trabies came out at the other, their bodies made from compacted trash. The final output was worth less than the sum of the inputs. What was not fully understood at the time was that East Germany’s whole economy was value-subtracting and cost-unconscious. In 1989, Hans Modrow, the last communist head of the GDR, put the East German economy’s net worth at 1.5 trillion West Germanmarks (DM). A year later, his Christian Democratic successor, ‘Lothar de Maiziere, slashed the figure to DM 800 billion. After unification, Detlev Rohwedder head of the privatization agency Treuhand, put the value of the assets on his agency’s books at a comparable DM 600 billion, but on second thought, a year later, lowered this assessment to zero assets and liabilities-just balancing each other out. In 1994 Birgit Bruel, Rohwedder’s successor, put the figure at minus DM 300 billion. By the end of1995 some DM 700 billion gross (more than $1 trillion) and DM500 billion net ($750 billion) of public money will have been spent on the “cure of Trabies.”

TRANSITION, a newsletter  of the WORLD BANK, Number 5-6, May-June 1996, page 15 

 

 

The Treuhandanstalt: 

East Germany's Transition to a Market Economy

by Sarah Corrie

Historical Background

On November 9, 1989 the world watched as thousands of Germans celebrated in the streets of Berlin. On this day, the wall dividing their two nations finally came down. The Berlin Wall was more than just a physical barrier separating a once united country. It symbolized four decades of communist ideology, socialism and the failing planned economies of eastern Europe.

The German Democratic Republic (East Germany) was formed in 1949 under the leadership of the Socialist Unity Party of Germany (SED - Sozialistische Einheitspartei Deutschlands). The SED's founders had pledged to "seek a distinctively German path to socialism" (Turner 47). In doing so they managed to improve economic conditions and experienced some of the highest growth rates in the eastern bloc. Despite the remarkable economic progress that was accomplished by East Germany, it became apparent in the 1970's and 1980's that planned economies had limitations. Socialist states could not compete with the living standards of the west. East Germany also suffered from labor shortages which proved a hindrance to growth.

When an international oil crisis struck in the early 1970's, East Germany experienced even greater economic set backs. World fuel prices increased at a much higher rate than prices of export goods in the GDR. Foreign exchange was essential in order to pay for needed oil and other imported materials vital to East German industries. This imbalance of trade revenue forced East Germany to borrow extensively, at high interest rates, from western markets. In 1970 the GDR owed western creditors approximately $1 billion. By 1981 this figure had increased to between $10 and $11 billion (Turner 202).

Central planners tackled the debt problem by neglecting the consumer sector and investing heavily in the production of goods for export. With capital tightly monitored, the conservative government continued to rely on their older, "proven" methods of production. They failed to experiment with innovative technologies of the west (such as microelectronics (Turner 203)) and never replaced outdated machines. Investment in export goods did manage to halt the debt growth by 1984. However, the long term costs of decreases in consumer goods, industries which failed to compete in world markets, and a widening of the east/west living standards gap proved much more burdensome in the long run.

"In 1970 the average income of a wage-earning household in East Germany was only 64% of the income in an equivalent household in West Germany. By 1983 this figure had dropped to 46% (Turner 204)." The following chart shows the number of hours East and West Germans had to work in order to purchase equivalent goods in the mid 1980's. It is clear that there is a large disparity between the real income levels in these two countries.

Consumer Good

Hrs. Worked

GDR

FRD

Color Television

846

15

Refrigerator

293

40

Woman's Dress

40

5

Children's Shoes

7

2

Source: Turner p. 205

During the 1970's and 1980's political tensions in East Germany decreased to a certain extent. In 1973 the German Democratic Republic became a member of the United Nations and soon afterwards many countries officially recognized it as a sovereign state. With this new found sense of "self", eastern politicians eased restrictions preventing western access to their nation. "Western journalists were allowed to operate in East Germany and vice versa" (Turner 192). Through this medium and also due to the increase in access to television and radio broadcasts from West Germany (as a result of innovations in communications technology), East Germans learned "first hand" of higher standards of living in the west.

The economic and political events occurring in East Germany also plagued other socialist states. By the late 1980's political unrest was wide spread. Mikhail Gorbachev's (head of USSR's Communist Party) unprecedented ideas of glasnost and perestroika and the end of the Cold War led many to believe the end of the eastern socialist empire was near.

Introduction

When the first layer of stone was removed from the Berlin Wall, it was clear that the political reign of the SED and its ideas of a planned economy had finally come to an end. At first, there were some hopes that the German Democratic Republic could remain as an independent nation. A political meeting was held in East Berlin in December 1989 with the goal of forming a plan for the democratization of a sovereign GDR. However, national poles in both Germanys showed that the public was ready to unite. When political unity became a reality, economists rapidly worked to determine how East Germany's economy could be privatized and assimilated into a highly competitive world market. The following paper describes the process of privatization, the agency responsible for implementing this rapid transition to a market economy (the Treuhandanstalt), and the present ramifications of its policies.

Creation of the Treuhandanstalt

The Treuhandanstalt (or Treuhand) was originally established by the government of the German Democratic Republic to act as the nations privatization agency before unification took place. At first this organization was relatively small with only a few hundred East Germans employed there. On June 17, 1990 the department was handed over to the West German government and officials from the Federal Republic were placed in all the Treuhand's positions of power. This was beneficial in that now the democratic system of checks and balances would be imposed on the privatization process. However, it also meant that the Treuhand would rapidly grow into a large corporate organization possessing inefficiencies that often plague these types of firms. "At the height of privatization in 1992 the Treuhand had approximately 4,000 employees, working out of one central and three branch offices (Gibbon 10)."

When the two Germanys were unified in October 1990, control of the Treuhand fell into the hands of Germany's Finance Ministry. At this time they owned the assets and liabilities of about 8,000 eastern enterprises and were responsible for reorganizing these firms. Not only did the ownership include the actual buildings and machinery of factories but also property such as kindergartens, vacation homes, forestry land, housing projects, etc. All together the value was originally estimated to be worth "about 600 billion Deutsche Marks (later it was discovered this was a highly overvalued figure). (Smyser 155)

Purpose of the Treuhandanstalt

The Treuhand had been formed from a GDR law based on the idea that the command economic model had to be abandoned. The holdings of the GDR needed to be regrouped and eventually sold to private investors. Germany chose a policy of rapid privatization by "low-price sales of industrial firms to investors who presented the best business plan with respect to investment and employment (Bšs)." It was important to privatize quickly but minimize the impact on the east by saving as many jobs as possible. The goal was to create competitive firms and privatize them by the end of 1994 (stated in article 25 of unification treaty).

Other disintegrating command economies were choosing to privatize through the use of vouchers. The Germans disregarded this idea for the main reason that they experienced an enormous migration of their citizens to the west. It would be very difficult to determine who was considered an East German citizen and who was not. Would those who left in the days before the wall came down be entitled to their voucher? What about the people who fled their shops before the Communists came to power. Another reason for abandoning the voucher idea was that East Germans did not have enough money to invest in companies and bring about the vast improvements that were needed. If rapid privatization was going to work, the east needed large amounts of investment capital which could only come from West Germany and foreign markets.

The process of reorganization was initiated by converting the eastern firms into about 13 thousand new entities (most organized as limited liability companies). During this process the Treuhand assess each individual firm and decided whether it should be reorganized or shut down completely. In the beginning privatizations went quickly. However, from September 1990 until March 1991 the process slowed due to the question of whether or not original owners should be compensated for property lost during the Nazi and Communist eras. The difficulty was that establishing a clear title of ownership was near impossible, yet investors refused to purchase property until all claims to it were absolved. Finally the "Impediments Removal Law was established saying that people with claims to property are entitled to it only if their investment plan is equivalent to the plans of other investors (Gibbon 12)." After this law was established privatization began again with vigor. In the first six months of 1991, 2,500 industrial firms were sold to the private sector (Bšs). Enterprises were sold to investors (or management buy-outs) at the rate of twenty per day from March 1991 until the middle of 1993.

Accomplishments

The mandate of the Treuhand expired at the end of 1994. At this time the organization had essentially transformed the East German planned economy into a privatized market economy in only four years. There were still a few companies and a large portion of the real estate holdings being sold in 1995. However, "ninety-eight percent of the enterprises held by the Treuhand have been privatized (German Information Center)." Most of these sales were made to West Germans who were "persuaded to invest a total $134 billion to rejuvenate firms and guarantee 1.5 million jobs (Van Voorst)." By early 1994 the following statistics were true...

  • 199 large and medium-sized businesses closed

  • 3,340 businesses being or have been liquidated

  • 1 out of 5 businesses taken in a management buyout

  • 2,591 enterprises purchased by East Germans

  • investment pledges by foreigners = $13.2 billion with $1.9 billion coming from US investors

By the time the Treuhand closed its doors, it had privatized about 14,500 companies. This rapid process of sales is considered a minor miracle by some.

Criticism of the Treuhand

The main criticism of the Treuhandanstalt is that its expenditures for restructuring firms were enormous. It was estimated that the organization spent about $222 billion during its life span. The chart below shows areas of finance which this figure was divided into.

Expenditure

Amount Spent in Dollars

Subsidies and Privatizations

$99.4 billion

Outstanding debts of East German holdings

$67.7 billion

Environmental clean up

$28.4 billion

Social Programs for Unemployed in East

$26.5 billion

Source: German Information Center Jan. 1995

Expenditures were in no way balanced by revenues since often times companies were sold for as little as one dollar in order for investors to put their finance directly into their newly purchased firms. The budget deficit created by the Treuhand grew close to 300 billion Deutsche Marks. To cover financing this debt the government has had to implement unfavorable taxes on German citizens and borrow " from Euromarkets at fairly favorable interest rates (Gibbon 13)." Many of the eastern German companies are still subsidized today. West Germans are angered by the amount of finance they have had to generate, which many feel has just been "squandered away (Van Voorst)."

Meanwhile the East Germans feel their country has been sold for mere pennies and their industrial base dismantled. "Three out of four manufacturing jobs have disappeared with the result that eastern Germany's unemployment rate lies at 21% in comparison to the national average of only 9% (Van Voorst)." The following chart depicts facts on employment in West and East Germany between 1990-1993.

 

1990

1991

1992

1993

West Germany (thousands)

Employed

28,487

29,219

29,470

29,340

Short-term

56

145

260

  450

Unemployed

1,883

1,689

1,810

2,115

Unemployment Rate

6.2

5.5

5.8

6.5

East Germany (thousands)

Employed

8,868

7,179

6,160

5,875

Short-term

758

1,617

375

200

Migrators (a)

450  

650

770

880

Commuters

85  

315

425

430

Unemployed

240

913

1,175

1,200

Unemployment Rate

2.6

11.3

16.0

17.0

Source: Heilemann p.6

(a)To West German labor force, cumulative since 1989

    

East Germans tend to feel that the Treuhand has destroyed more than it has created by laying off thousands of workers from companies capable of production, creating mass unemployment and not replacing it with anything. It has "deindustrialized the world's tenth-largest industrial economy by deceiving the nation and selling out the East Germans (Gibbon 20)."

Many in East and West Germany alike feel that the quick privatization approach was fundamentally flawed. It created hasty sales of property at prices far below the real market value. These critics feel that a slower process of restructuring should have been initiated so that there could have been more success at selling firms at higher prices, creating less of a budget deficit. The "quick sale" theme also generated more corrupt speculators who "stripped companies of their assets" or "operators who didn't have the resources to run them" (Gibbon 21).

Successors to the Treuhand

When the Treuhand dissolved at the end of 1994, its responsibilities were passed on to four successor organizations. Their main goal is to finish the uncompleted work of the Treuhand and resolve future problems which are sure to arise from the privatization process.

The Federal Agency for Special Tasks Resulting from Unification (or BVS) is essentially what is left of the former Treuhand. Its "duty is contract management (German Information Center)." Today it supervises 85,000 contracts and still has to liquidate about 3,500 companies which were permanently closed by the former Treuhand. Its staff consists of about 2,300 workers but this number will diminish over the years.

Much of East Germany's public land (forests, farms, etc.) are still owned by the German government. The Property Agency (or TLG) is responsible for administering to and, in the end, selling this land. About 62,000 properties still remain to be sold.

There are still approximately 100 companies (with about 40,000 workers) remaining to be sold. This responsibility lies in the hands of the Participatory Management Agency (or BMG). An example of one of these companies is Mansfelder Copper and Brass. It consists of 1,800 employees. (German Information Center)

The final successor agency is the Agency for the Solution to Unsettled Property Issues (or Barov). At this point in time its only goal is to take over the "public sector tasks" from the Federal Agency for Special Tasks Resulting from Unification (BVS) on January 1, 1997.

Where Germany Stands Today

Today Germany is plagued with frightening unemployment rates, the continuation of large subsidies to the east (toping $100 billion in 1995), and a $36 billion government budget deficit. "Structural problems consist of high real wages (in both the east and west) and slowing productivity. The government needs tight fiscal and monetary policies to counter the budgetary and inflationary impacts of huge spending on unification (Kortez)."

Another problem driven by the west/east parent-child relationship has been the fact that labor unions in West Germany have expected East German wages to rise to higher standards almost over night. "West unions let the east believe that equalizing wages quickly was doing them a favor. Instead, this made eastern industries less competitive by driving up their unit-labor costs higher than levels in West Germany (Business Week)." West German unit-labor cost levels were already among the highest in the world. The result of this is that foreign investors in Europe tend to look towards markets in Poland, Hungary, and the Czech Republic where lower labor costs make firms more competitive. In order to create competitive industries Germany needs to reduce instances of higher pay. However, this policy is obviously fought by workers everywhere.

Helmut Kohl has entered his fourth term as German Chancellor. In his political campaign he stated his dedication to create global competitiveness by

  • - cutting labor costs

  • - privatizing state industries

  • - trimming welfare benefits

  • - curbing farm subsidies

*source: Business Week International Editions

With Germany joining the European Union, Kohl hopes to be "the bridge between western Europe, Poland, the Czech Republic, and other democracies to the east." He also is looking to expand industries to foreign sectors, specifically Asia. Here Germany expects to experience growth through lower labor costs.

Conclusion

Most people would agree that regardless of current economic conditions, East German markets have been fundamentally strengthened and modernized. Most economists feel that productivity levels will rise in the future. East German share of overall German GDP already increased from 6.4% in 1991 to 10.3% in 1994. Now that transformation has basically been completed the economy needs time to recover from the costs of unification.

Regardless of the criticism attached to the Treuhand, it did complete 95% of its goal of rapid privatizations in the time it was allocated. The process has produced tremendous costs. However, no one has every attempted this type of transformation before. There was no standard manual to follow on how privatizations should be done. At the same time no one knew the condition of the East German economy until the Treuhand took charge. Expectations were high since East Germany was considered the most successful of the command economies. In reality, it was later stated by Brigit Breuel (head of the Treuhand) that "virtually no existing E. German firm was competitive in the world market". At the same time all of the eastern command economies' markets (which East Germany depended heavily on) were failing.

The Treuhand was given an incredible task and expected by many to create miracles. It is obvious that mistakes have been made by the agency but as Breuel stated, "in a bureaucracy created so hastily for such an epic task, mistakes are inevitable." It is to soon to judge the economic implications of the Treuhand policies. With time, economic recovery is bound to come and then people might look back on the Treuhand with less anger and frustration. In the end, east German markets will be more competitive than the socialist planned economies and Germany as a nation will improve its economic power.

Sources

  • Boes, Dieter. Privatization in East Germany: A Survey of Current Issues. IMF Working Paper, 1992.

  • Gibbon, Marian J., Mack, Kathryn S., and Shingleton, Bradley A. Dimensions of German Unification: Economic, Social, and Legal Analyses. San Fransisco: Westview Press, 1995.

  • Heilemann, Ullrich and Jochimsen, Reimut. Christmas in July?. Washington D.C.: The Brookings Institute, 1993.

  • Merkl, Peter H. German Unification in the European Context. Pennsylvania: The Pennsylvania State University Press, 1993.

  •  Smyser, W.R. The Economy of United Germany: Colossus at the Crossroads. New York: St. Martin's Press, 1992.

Sources From the Internet

  • Van Voorst, "Treuhand's End" Time (Jan. 28, 1995).

  • "Finally, Germany is Paring the Fat" International Business (October 17, 1994.)

  • "Germans Finally Hop" Business Week (March 6, 1995).

  • "Stop Throwing Good Marks After Bad" Business Week (June 26, 1995).

  • "The Treuhandanstalt" German Information Center New York (January 1995) Address: http://langlab.uta.edu/Docs/GIC_FOCUS/FOCUS_95_1_January.txt

  • "The Worst is Finally Over in East Germany" Business Week (June 19, 1 995).

  • "Why Kohl Can't Rest On His Laurels" Business Week International Editions (October 31, 1994).

  • Reuters News Service (November 22, 1995).

 

Privatization of East Germany:

Treuhandanstalt's Fire sale

by Michal Arian

After the fall of the Berlin Wall and the reunification of Germany (East and West) many things had to be accomplished before Germany could truly be united. One of the main tasks was converting East Germany from socialism to capitalism. The government and the economy had to be almost completely rebuilt. The people also had to be almost entirely retrained to live and work in a capitalist and democratic society. Since under socialism almost all of the East German enterprises and land were publicly owned, they had to be sold to private companies and investors before capitalism could operate properly. This is far from a simple task. "The most important is the crucial role of private ownership and the linkage among legality, democracy, and prosperity"(1). The economy was made up primarily of a small number of large enterprises and there was an extremely high level of concentration within most of industries. Most of these giants had to be broken up into smaller companies and sold separately. Also many of these enterprises were not economically stable and had to be restructured before they were sold (2). If this wasn't hard enough, the government decided that the best way to go about the transition was by utilizing the 'shock therapy' strategy. Shock Therapy was defined by Andreas Oplatka as "the merciless, socially painful prescription designed to quickly replace the futilely grinding mills of the socialist economy with efficiency and profit and all the benefits of free competition"(3). Because of this privatization had to be done very quickly. It had to be done well though because privatization would in turn determine present and future economic success. If many companies were to be sold to bad investors then the economy would be adversely effected.

Treuhandanstalt, a trustee agency, was given the task of privatizing East German economy (4). Its job was to sell all the previously public enterprises to private investors. The problem was that it was forced to do it very quickly. After unification in 1990, Treuhandanstalt had 14,000 companies and millions of employees in it's books(5). To privatize an entire country, large amounts of managers, investors, accountants, and money are needed. This turned out to be another major problem. "The privatization dash was driven by the unquestioning faith of Bonn politicians in the healing powers of the market. It was a shock to find that foreign business did not share the government's enthusiasm for eastern Germany. ""Investors were hardly queuing up"" says Rudiger Pohl, head of the IWH economic institute in Halle"(6). Even though Treuhandanstalt sold all but 60 companies by the end of 1994, the lack of investors forced them to take on 60 billion dollars of old East German debt leaving them with 173 billion dollars in losses(7).

The Treuhandanstalt knew that the future success of the country depended on the success of the privatization process. Because of this it "shuttered 300 deadbeat companies"(8) even though it may have increased unemployment and political unrest. Treuhandanstalt felt that subsidizing and revamping these companies before sale improved the companies and the economy as a whole. "Privatization is the best way of making these companies healthy"(9).

By the end of 1994 Treuhandastalt's task was almost entirely completed. But problems existed and the economy was slumping. By the end of 1991 the economy had slid to half of the level prior to the unification(10). Many company losses were also expected in the future. One of the problem's was that since Treuhandanstalt was rushed in the privatization it didn't have time to check out investors(11). The time constraint resulted in the lack of supervision and that led to many poor sales decisions. Since there was shortage of investors, lesser quality investors had often to be accepted if the companies were to be sold. Foreign investors frequently offered more money but in an attempt to keep Germany German owned Treuhandanstalt often favored East German investors (12). Out of 3,800 companies sold by 1991 90% were to Germans(13). Not only did this cause losses in revenue it also caused many foreign investors to loose interest.

Western Europe, who is East Europe's largest subsidizer, has ended up benefiting more from their subsidies than the East. The West has been flooding East German Markets with goods and has successfully turned a past trade deficit into a large trade surplus (14). This foreign flooding of the East's markets has made it difficult for the new East German companies to get off the ground. "The initial hope was that our western allies would finally liberate us...It hasn't turned out that way"(15).

One of the problems was caused by the new unified German government itself. Not only did it create privatization problems by moving it along at great speeds, but it also dismantled the socialist central planning before capitalist market economy was created. "In the course of the transformation, the old disappeared before the new was built"(16) This left a large gap resulting in the loss of tax revenue, output, exports, and increased budget deficit and dependency on imports from other countries. "The needs of the population and the state have not decreased with the fall in productivity. Thus, the budget shows a huge deficit, the trade balance deteriorates, and inflation risk grows"(17). Even though privatization went smoothly and almost all of once public Germany is now privatized, many problems still exist and East German economy is worse than ever.

It is too early to tell if East German transition from socialism to capitalism was a success. It may take years before the new economy matures.

FOOTNOTES:

  • 1) World Press Review, pg. 40, Feb. 1995

  • 2) Business Week, pg. 54 May 6 1991

  • 3) World Press Review, pg. 16, Nov. 1993

  • 4) World Press Review, pg. 36, March 1995

  • 5) World Press Review, pg. 36, March 1995

  • 6) World Press Review, pg. 36, March 1995

  • 7) Business Week, pg. 54, May 6 1991

  • 8) Business Week, pg. 54, May 6 1991

  • 9) Business Week, pg. 54, May 6 1991

  • 10) Business Week, pg. 54, may 6 1991

  • 11) World Press Review, pg. 36, March 1995

  • 12) Business Week, pg. 50, Nov. 25 1995

  • 13) Business Week, pg. 50, Nov. 25 1995

  • 14) World Press Review, pg. 41, Feb. 1995

  • 15) World Press Review, pg. 41, Feb. 1995

  • 16) World Press Review, pg. 16, Nov. 1993

  • 17) World Press Review, pg. 16, Nov. 1993

BIOGRAPHY:

  • 1) "Germany's Fire Sale Wraps Up" J. Eisenhammer. World Press Review, v. 2, pg. 36, March 1995.

  • 2) "Germany's Telecom is Calling For Investors" Rechlin. Business Week, pg 50, Oct 26 1992.

  • 3) "Economic Rebirth of Eastern Europe" A Robinson. World Press Review. v42 pg 40-1, Feb 1995.

  • 4) "Rebuilding The Economic House" T Bauer. World Press Review. v40 pg 17, Nov 1993.

  • 5) "Birgit Bruel May Have the Toughest Job in Germany" J Templemen. Business Week, pg 44, May 6 1991.

  • 6) "Dark News From Eastern Germany" H.H.Kroll. World Press Review, 38:48, May 1991.

  • 7) "The Great German Auction is Looking Like a Private Sale" I Reichlin. Business Week, pg 50, Nov 25 1991.

  • 8) Asmus, Ronald d, "German Unification and it's ramifications". Rand, California, 1991.

 

 

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