At a lunchtime meeting on 16 November, Michael Burda spoke on the economic consequences of German unification. Dr Burda is Associate Professor of Economics at the Institut Européenne d'Administration des Affaires (INSEAD), Fontainebleau, and a Research Fellow in the International Macroeconomics programme at the Centre for Economic Policy Research. His talk was based on CEPR Discussion Paper No. 449, `The Consequences of German Economic and Monetary Union'. This paper and the meeting form part of the Centre's research programme on `The Economic Transformation of Eastern Europe', for which financial support is provided by the Commission of the European Communities under its SPES programme. The views expressed by Dr Burda were his own, however, and not those of the Commission nor of CEPR, which takes no institutional policy positions.

Burda began by noting that recent events in Germany and in Eastern Europe have made `back-of-the envelope' calculations respectable among economists once more, since the only data available for more sophisticated calculations are incredible, obsolete, or referring to items that no longer exist. He argued that many recent assessments of German economic and monetary union had exaggerated its monetary implications and correspondingly neglected its real effects. Monetary union brought about a one-off shift in the level of the DM-zone monetary aggregates commensurate with the increase in real activity implied by economic union, whose effects were largely complete by 2 July 1990. On the other hand, the real effects of converting all transactions at the 1:1 rate have increased the risks of structural unemployment, large-scale emigration, low foreign investment and the development of a `Mezzogiorno syndrome' in Eastern Germany.

Burda maintained that factor mobility will play the key role in determining the fate of Eastern Germany in the next decade. Mass migration to Western Germany is likely if conditions deteriorate as expected in the East. This may be forestalled by the movement of physical capital in the opposite direction, but this will depend critically on private sector perceptions of investment opportunities and the settlement of outstanding disputes over property rights.

Burda argued that the real resource flows implied by German economic and monetary union are staggering, but nevertheless manageable within ten years. He maintained that the living standards of the two zones measured in real terms differed by a factor of at least 4:1, while Eastern Germany suffered from open unemployment of some 750,000 and hidden unemployment of about 2 million. Equipping Eastern German workers with half the public and private capital stocks of their Western German counterparts at 1990 prices would require expenditures of roughly DM 2 trillion, i.e. a resource flow of roughly DM 200 billion per year over a ten-year period. This figure is additional to the increase in Eastern Germans' consumption that would be required to dissuade them from migrating to the West.

Burda noted that the current surge in demand for both investment and consumption goods in Eastern Germany and the rest of Eastern Europe has raised activity in Western German industries to operating levels not witnessed since the late 1960s. This will lead to a real exchange rate appreciation in the short run, which will probably be undone in the longer run, however, as the DM- zone moves into deficit.

The danger of migration might alternatively be averted by deliberately maintaining the prices of non-traded goods, such as housing, transport and energy, at their current low levels. If such a `relative price divide' kept Eastern German product wages low in in the near term, this would promote investment and discourage migration. Such a policy would also be relatively easy to implement, since many of these prices are controlled by the state, and Eastern Germany as the lower productivity region should have lower price levels in any case. Regulating the prices of such non-tradables may slow the renovation of the housing stock, but this would enable more economically justifiable investment in productive equipment to take place. A major programme of public investment in the East would further enhance its total factor productivity, thus enabling both wages and profitability to rise.

Burda also noted a number of institutional features peculiar to Germany that will complicate and perhaps worsen matters. First, unemployment benefits in Western Germany provide insufficient pressure on workers to change occupations, while those in the East, although low in absolute terms, have no effective time- limit. Second, the legal `extension' of wage agreements reached through collective bargaining to cover non-unionized enterprises will impede outsiders including newly unemployed Eastern Germans from underbidding employed workers in either region. Third, the practice of Kurzarbeit (or `short-time work') whereby the (West) German government subsidizes the reduction of working time, has now been extended to the moribund Eastern German enterprises, thus removing pressure of threatened bankruptcy and postponing structural change. Fourth, the state property office (the Treuhandanstalt) is encountering considerable difficulties in selling off state property. If a slow-down of privatization reduces the flow of transfers to the East, the necessary restructuring will be further postponed as enterprises receive further subsidies for short-time work or from the common earnings fund managed by the Treuhandanstalt. Under such conditions, managers of state-owned firms have little incentive to resist wage increases and may behave as `agents without principals', although Burda noted that the government might reduce this subsidy to permit the emergence of open unemployment following the election of 2 December.