Reinhard Kache stands in the middle of the cobblestoned central square in Halle, a sleepy university town 92 miles southwest of Berlin. The 65-year-old retired chemical engineer is waiting for the start of the Montagsdemonstration, or Monday demonstration, which has become a weekly event here and in cities across Eastern Germany since the government of Chancellor Gerhard Schröder this summer announced sharp cuts in welfare spending.
Once a lead researcher at the giant Buna chemical plant outside Halle, Kache was laid off a decade ago along with more than 20,000 co-workers as part of a drastic restructuring, and he never worked again before taking retirement this year. He regards Schröder’s welfare cutbacks, which will slash benefit payments to many of his former colleagues, as the final slap in the face from a government, and society, that has written off Eastern Germany.
“Germany helped Spain and Portugal when they needed help. They are paying for ex-Yugoslavia. But they don’t have enough money for us,” says a bitter Kache, who spends his time volunteering at his former union and helping unemployed families.
Fifteen years after the Berlin Wall fell, raising hopes of unity and prosperity in both East and West, Germany stands as divided as ever. In Eastern Germany anger and frustration over an 18.3 percent unemployment rate erupts in the Montagsdemonstrations throughout the region, and growing numbers of people are turning to extremist parties for solutions. The Party of Democratic Socialism, the successor to the Communist Party that ruled the German Democratic Republic for four decades, has become the largest in the region. More worrying is the sudden rise of the neo-Nazi National Democratic Party of Germany, or NPD, which in September won 9 percent of the vote in regional elections in the states of Saxony and Brandenburg.
In Western Germany, meanwhile, citizens’ sympathy with their countrymen has given way to impatience and anxiety over the seemingly unending costs of reunification. Since 1989, Germany has shelled out a massive E1.3 trillion ($1.6 trillion) -- more than 50 times the $30 billion in reconstruction aid given by the U.S. to postwar Europe under the Marshall Plan -- to raise Eastern living standards and modernize the region’s antiquated infrastructure. Spending on the East is still about E80 billion a year, or nearly 4 percent of GDP, an outlay that is hampering the Schröder government’s attempts to bring its budget deficit below the 3 percent-of-GDP ceiling for euro-zone countries.
The welfare cutbacks, which apply nationwide but hit hardest in the East, are the most ambitious attempt yet by the government to balance its books and restore Germany’s flagging competitiveness. Although Schröder has defended the cuts on grounds of economic necessity, they represent an implicit admission that the culture of subsidy Germany has fostered in the East needs to change -- and change quickly.
As Horst Köhler, the former International Monetary Fund chief who became Germany’s president earlier this year, put it in a recent interview with the German magazine Fokus: “There were and are everywhere in the republic large differences in living standards. If you want to level them out, you cement the subsidized state and place an intolerable burden of debt on the next generation. We have to get away from the subsidized state.”
Tensions over the price of reunification have been brewing for years, of course. The costly burden of modernizing the East at a time when companies in Western Germany are struggling to compete with emerging economies like China has contributed to a lost decade in which Germany, Europe’s onetime economic engine, has been the region’s laggard. The reunification debate gained fresh urgency, however, with the May accession of eight Central and Eastern European countries to the European Union.
By necessity, these countries have followed a very different model of development than Eastern Germany. With relatively little aid to fall back on, they have used low wages and low tax rates to generate strong growth and attract large inflows of foreign direct investment -- and jobs -- over the past decade. Their admission to the EU, which gives them the same political stability and legal certainty as Eastern Germany, promises to step up the competitive heat.
“The biggest pressure for German autoworkers is just three kilometers east,” in countries like neighboring Poland and the Czech Republic, says Ferdinand Dudenhöffer, director of the Center of Automotive Research in Gelsenkirchen. Manufacturing wages average about E16.50 an hour in Eastern Germany, he notes, compared with just E4.48 in Poland and E4.85 in Slovakia. Although Bayerische Motoren Werke, Porsche and Volkswagen have dutifully invested in new manufacturing plants in Eastern Germany, Slovakia has in recent years won most major investments by non-German companies, including France’s PSA Peugeot Citroën, Japan’s Toyota Motor Corp. and South Korea’s Hyundai Motor Co. Even VW assembles more cars at its two plants in Martin and Malacky, Slovakia, than it does at its ultramodern, glass-walled factory near Leipzig.
Increasingly, German companies are using the big wage gap to extract labor concessions at home. Siemens, which has a large presence in Eastern Europe and employs more than 7,000 people in Slovakia alone, persuaded some of its workers in Western Germany to work longer hours and accept smaller Christmas bonuses after threatening to move its mobile-telephone assembly operations to Hungary. VW, one of the nation’s biggest employers, is in the midst of tense negotiations and has threatened to shift more production offshore unless it obtains labor concessions at home.
The competition from the new accession states has prompted threats of retaliation from Berlin. Germany believes that the eight new EU members from the region are unfairly attracting investments and jobs with low corporate tax rates that vary from 10 percent to 19 percent in most of the countries, compared with a rate of 38.5 percent in Germany. “This creates a competitive situation that is problematic for the current members of the European Union,” Chancellor Schröder said recently. He is calling for cuts in EU regional aid to countries with low tax rates, a stance that has won support from France.
The German threats are almost certainly bound to fail, however, because of opposition from countries like the Netherlands and the U.K. as well as the new accession states themselves. As a result, Eastern Germans will have to rely on their own hard work and innovativeness, rather than on handouts, to increase living standards.
“After 15 years we need to seriously rethink economic promotion” in Eastern Germany, says Michael Schädlich, a professor of economics at the Institute of Structural Policies and Economic Development in Berlin. Instead of propping up old industries with subsidies, the government needs to foster the growth of new industries and jobs by promoting research and innovation, improving education and training and building what Schädlich calls a “cooperation culture” between industry and scientific researchers. “We are at a transition now,” he says. “We need new ideas, new impulses. We need to do more with less money.”
Schröder’s Social Democratic government defends its record in Eastern Germany even as it gradually tries to shift policy away from subsidies. Manfred Stolpe, the regional planning minister who oversees development efforts in the East, says critics overlook the dilapidated state of the region’s housing and infrastructure as well as the environmental damage created under Communism.
“We needed practically to start from scratch,” Stolpe tells Institutional Investor. “We have reached a level where Eastern Germany is at about 70 percent of the economic power of Western Germany. That cannot be seen as unsuccessful, even if further efforts are necessary. The success of our rehabilitation of our cities and the environment are in the truest sense apparent.”
The E156 billion in development spending earmarked for the region through 2019 will be targeted to develop industrial clusters -- automotive industry in Saxony, chemicals in Saxony-Anhalt and communications in Berlin and Brandenburg, for example. That money, combined with the government’s labor reforms, should promote jobs and growth, Stolpe insists.
“Eastern Germany already is an attractive region for investors,” he says. “We are sticking to our goal of equalizing living standards with Western Germany. Don’t forget, we still have a lot of time. The Solidarity pact [which imposes an income tax surcharge to finance development in Eastern Germany] runs until the end of 2019.”
The opposition Christian Democratic Union, led by Angela Merkel, who hails from Mecklenburg, Eastern Germany’s poorest region, accuses the government of timidity. It also proposes encouraging the unemployed to take low-paying jobs by topping up their wages with benefits. Merkel has failed to get the party to endorse more aggressive labor and tax reforms, however, which demonstrates the political difficulty of promoting change in such a consensus-bound country.
The neo-Nazi NPD offers more of an emotional appeal than a coherent economic alternative, criticizing German companies that invest in low-cost producers abroad as immoral.
All this domestic discontent is a far cry from the heady optimism of November 9, 1989, when tens of thousands of euphoric Germans converged on the Berlin Wall and began breaking down the cold war barrier. Some 21 percent of Germans polled recently said they wanted the Wall to be resurrected. It’s no wonder. The one unifying factor in the new, larger Germany is that life has been harder for everyone.
Unemployment in Eastern Germany, which barely existed under Communism, has skyrocketed to 18.3 percent of the labor force -- topping 20 percent in some regions -- more than double the 8.4 percent rate in Western Germany. Eastern living standards have risen but still lag badly. Average income stands at E17,528, compared with E27,671 in Western Germany. By comparison, per capita income is E16,300 in the Czech Republic and E13,700 in Hungary on a purchasing power basis; but unemployment rates in those countries are 7.6 percent and 5.8 percent, respectively.
“Fifteen years ago East Germans were promised things would be nice and beautiful, and now they get angry because they aren’t,” said Johannes Stephan, professor of Central and Eastern European studies at the Halle Institute for Economic Research.
Western Germans, on the other hand, have seen their living standards suffer as a result of high taxes tied to reunification and sluggish economic growth. Most Germans continue to pay a 5.5 percent “solidarity” tax, which raises the top income tax rate to 50.5 percent. The surcharge, imposed in 1990, was supposed to expire in 2000 but was extended until 2019 because of the East’s failure to catch up. According to a recent poll conducted for the newspaper Die Welt, 52 percent of Western Germans surveyed consider that the E80 billion being sent to the East each year is too much, and 32 percent believe their Eastern cousins are lazy.
The combination of high costs and high taxes has been a lethal economic cocktail for Germany. After enjoying a short-lived postreunification boom, the economy has sputtered for the past decade. It grew by just 0.2 percent in 2003 and is forecast to expand by a modest 1.5 percent this year, below the EU average of 2 percent. Poland, by contrast, is forecast to grow by more than 6 percent this year, while the Czech Republic, Hungary and Slovakia are expected to grow by 3.5 to 4 percent.
Many of Germany’s economic ills, East and West, stem from the terms of reunification itself. When the two countries came together in 1990, then-chancellor Helmut Kohl agreed to exchange East Germany’s ostmarks for deutsche marks at a rate of one to one, compared with the official exchange rate of 4.4 to one and a black market rate of nearly ten to one.
Politically, the decision gave Eastern Germans a real stake in their new country and encouraged them to stay at home rather than migrate west. “Demand for parity was so strong, from the politicians, from the public, everyone. People were afraid there would be a brain drain from the East,” says Oliver Strönner, an emerging-markets economist at Commerzbank in Frankfurt. “There was no political alternative.”
Economically, however, the decision saddled an industrially backward region with uncompetitively high wages. What’s more, the East also adopted most of West Germany’s rigid labor laws, heavy bureaucracy and high social welfare costs. The result was sadly predictable. As Karl Dannenbaum, chief executive of Lehmann Brothers Deutschland, puts it, “Why would you move a company to East Germany under those circumstances?”
Massive doses of government aid have failed to jump-start the economy. In addition to the enormous internal transfer of funds, Germany has been the biggest recipient of EU development assistance for the past six years, ahead of Greece and Spain. A company looking to invest in Eastern Germany can get up to 50 percent of its costs subsidized through a combination of EU and German aid, says Ulrike Handtke, senior manager of financial services for the Industrial Investment Council, an economic development board sponsored by the German government and the six Eastern states.
The largesse hasn’t created enough new jobs, however. To see why, one only has to look at the privatization of Kombinat VEB Chemische Werke Buna in Schkopau, just outside of Halle. The sprawling chemical complex covered 500 hectares (1,236 acres), with some 2,700 buildings, 174 kilometers of rusting railways and 94 kilometers of roads. In addition to producing synthetic rubber and polyethylene, the complex provided a health clinic, day-care center, apartments and a cultural center for the plant’s 27,000 workers and their families.
Dow Chemical Co. acquired the complex in 1994 in one of the biggest privatizations in Eastern Germany. The U.S. company received a total of E4.6 billion in government aid to clean up the environmental damage caused by decades of dumping chemicals in the ground and to provide welfare benefits to the many employees who were laid off. Only E1.5 billion in state money, along with E1.2 billion from Dow, was spent on bringing the plant up to Western standards. Today there is green space between the 300 buildings on the site, now called Buna Sow Leuna Olefinverbund, and the smokestack emits a white, billowy cloud instead of the black soot that used to pollute East Germany.
“Olefinverbund is a key European manufacturing center for Dow and an integrated component of our global supply network,” Dow Chemical chairman and CEO William Stavropoulos tells Institutional Investor. True, but the plant employs only 2,300 workers, less than one tenth its Communist-era payroll. Dow also spent E300 million to build an industrial park on the site for suppliers and firms that use the plant’s chemicals; that created an additional 600 jobs.
Similar exercises were repeated by other big chemical companies, including Bayer and Italy’s Menarini Group, throughout Eastern Germany. Next year the region’s chemicals industry, once the largest employer, with more than 300,000 workers, is expected to produce the same volume of chemicals as it did in 1989, but with one tenth the workforce. Still, the industry remains the largest employer in the region.
All told, the government privatized some 14,000 state-owned enterprises in Eastern Germany between 1990 and 1994, selling the vast majority of them to companies in Western Germany. Roughly 3,400 other enterprises were liquidated or shut down.
The net result? Germany saved and modernized a chunk of the East’s outdated industrial base, but at a huge public cost of E138 billion. The aid failed to generate enough jobs or transform Eastern Germany into a magnet for foreign investment, a government-appointed commission concluded this summer. If Germany really wants to stimulate jobs and investment in the region, the panel suggested, it should concentrate future aid in areas that are already showing signs of life. One of those would be the city of Leipzig, a half-hour drive east of Halle.
The city once boasted Johann Sebastian Bach as its choirmaster; a century ago it was one of Germany’s wealthiest areas. Traditionally a trading post between Europe and Asia, it claims to have the world’s oldest fairground. The local university was one of Germany’s most prestigious, with the country’s second-largest library. Leipzig’s train station, a monument to the Victorian era, is one of the biggest in Europe.
In its heyday in the 1920s, the city had more than 700,000 residents. Nowadays Leipzig, which has shrunk to some 500,000 residents, looks like a movie set. The turn-of-the-20th-century buildings downtown have been spruced up, but the local unemployment rate is 20.3 percent and many of the new shops and restaurants are nearly empty. At 8:30 on a weekday morning, the renovated train station, which has won two architectural awards, contains only a handful of people.
Yet by Eastern standards, the city has had its share of successes. BMW will start production of its 3-series model next spring at a new, E700 million plant in Leipzig. The automaker reportedly paid just E2 million for the 200-hectare site, selected from among 250 contenders, and is receiving another E200 million in subsidies to build the factory.
Porsche built an assembly plant in the city to produce its Cayenne sport utility vehicle and recently expanded the facility to make its Carrera sports car as well. Announcing the selection of Leipzig in 1999, CEO Wendelin Wiedeking said the company was financing the E128 million plant on its own because “luxury and state subsidies do not mix.” The plant and the suppliers that have set up nearby employ more than 400 people.
But as much as the city welcomes automakers like BMW and Porsche, it needs to develop new, high-tech industries to thrive, asserts Michael Schimansky, head of Leipzig’s economic development department. “We don’t want to be in competition with Poland or Slovakia. We can’t because of salaries,” Schimansky says. “We want to be more than simply an assembly plant site.”
Thus the city is focusing its promotional efforts on a handful of industries, including biotechnology, information technology and energy and environmental technologies. In May 2003 the city, in cooperation with the University of Leipzig and the Max Planck Institute, opened a E43 million, 20,000-square-meter complex called BioCity Leipzig, offering state-of-the-art office and laboratory space for biotech companies. Some 70 percent of BioCity has been occupied in the first year, with tenants lured by a bargain-basement rent of just E7 a square meter, says executive director Jörn-
Heinrich Tobaben. “My job is to bring in jobs, jobs, jobs. That’s it,” he notes. Today firms at BioCity employ 231 workers.
The city has had some modest success in luring biotech businesses. One new entrant is NeuroProgen, founded in 2003 by Sigrid Schwarz, a graduate of the California Institute of Technology, and three colleagues. Schwarz returned to Leipzig after completing postdoctoral work on Parkinson’s disease. She hopes to find a way to cure the degenerative illness by injecting neural stem cells into the brains of Parkinson sufferers. NeuroProgen, which was started with an E800,000 government grant, employs six researchers and is producing cells to begin clinical studies.
“Capital markets now are too cautious to invest in high-risk projects,” Schwarz says. “We wouldn’t have been able to get funding.”
Eastern Germany needs to encourage more risk-taking like that to prosper, says Stephan, the Halle Institute professor. “Managers in Eastern Europe will tell you that they had it much harder,” he says. “But ultimately they had to spit in their hands and get to work. What we need to sort out the labor market in Eastern Germany is the entrepreneur -- people who are willing to take a risk, invest in a company and be willing to go broke.”
Concentrating a reduced amount of aid on relatively vibrant areas like Leipzig may make sense as clusters of companies can attract investment and create demand for other services. Politically, however, changing the way the government disburses aid won’t be easy. More-deprived areas like the eastern part of the state of MecklenburgWest Pomerania, which borders Poland, stand to lose billions of euros and are already fighting to keep their share of pie. And the Monday demonstrations, which have drawn thousands of people across the region to protest any diminution of state aid, are continuing, although the number of protesters is dwindling.
Nevertheless, economics professor Schädlich says he is hopeful that Germany will find more effective ways to promote growth in the East. “The problems now are so high. This is a good chance for us to try new solutions,” he says. “As an economist, I am optimistic. As a citizen, I hope so.”
