West Germany opted for rapid unification with the East as a reaction to a huge wave of immigration from East Germany. Assessments of the East German transition commonly focus narrowly on the size of financial transfers from the West to the East. Of more relevance to other cases of transformation is the fact that East Germany was immediately brought into the trading and financial system of the world economy and immediately adopted Western legal and administrative structures. German union thereby created a unique environment for transformation in East Germany.

In discussion paper No 1296 Research Fellow Jürgen von Hagen reviews the main elements of German union: monetary union, fiscal union, legal and administrative union, and rapid privatization. He then reviews the main economic developments since 1990. From a macroeconomic perspective, unification has promoted East Germany's fast integration into the Western trading and financial system. These factors may help in the longer run to overcome the huge terms-of-trade shock implied by monetary union and the loss of traditional external markets. On a politico-economic level, German union has created an environment favourable to a big-bang strategy of reform by reducing the distributional problems reform processes may face and that have led to stalemate in the political process in other transition countries. The East German labour market was drawn into the West German pattern of industrial relations, which have traditionally favoured insider-outsider behaviour. The result has been a massive destruction of employment. Thus, the worst mistake in the unification process was the immediate extension to the East of labour market regulation that favours insider-outsider behaviour.