United for 30 Years — Catching up to West Germany

14 minute read

Visualizing 30 years of economic data between East and West Germany

The year 2020 is certainly a special year for many people. A global pandemic and the election of the next US president are just two out of many examples. For Germany, the year 2020 is historically important for another reason. Thirty years earlier, on October 3rd, 1990, the reunification of Germany took place. With five “new federal states” and the reunited city state of Berlin, the territory of what had been Communist East Germany, the German Democratic Republic became part of the Federal Republic of Germany (West Germany).

It is important to stress that the historical context of the split and reunification of Germany fills several textbooks. This blogpost is trying to provide the most remarkable historical pieces to give an overall understanding of the situation to make the reader be able to put the number into better context.

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Source: pixabay

Historical Context

In the aftermath of the second world war, Germany was divided into four occupation zones for each of the four allied forces, namely the Soviet Union, the United States of America, the United Kingdom and France. The capital, Berlin, was equally divided amongst these four.

Between 1947 and 1949, the three zones of the Western allies merged together to form the Federal Republic of Germany, with its capital in Bonn. On the other hand, the Soviet Zone split off to form the German Democratic Republic. West Germany was a capitalist state and member of the NATO, East Germany was Communist and a member of the Warsaw Pact.

Many years later and shortly after the death of Chernenko, who was until his death in 1985 leader of the Soviet Union, Gorbachev was voted unanimously into power and became the eighth leader of the Soviet Union. What followed was a time of drastic political change. A time marked by a freer press, the withdrawal of combat troops from Afghanistan, and the urge to free the world of nuclear weapons by the end of the 20th century. Even a desire for more democracy. [1]

Losing the political backing of the Soviet Union, which was also distracted by its many domestic issues, the German Democratic Republic started to crumble apart up until its end in 1990. The subsequent economic restructuring of the East resulted in significant costs, mainly paid for by West Germany. These payments comprised an average amount of around 100 billion euros per year [2]— an amount which was grossly underestimated in 1990, a time at which the German government still thought that no tax increases were necessary to finance the reunification. [3]

On the 30th of January 1991, the German government announced the so-called Solidarity Surcharges, a tax increase which was levied to cover the huge costs of the reunification and other international involvements of Germany. In 2021 this tax will soon be part of history for around 90 percent of the people. [4]

Thirty years after the reunification, the question might be asked whether the government’s investment reached its goal to equalize the economic situation of East and West. This blog-post uses GDP per Capita data for all 16 German states over time to analysis and visualize the trend in this metric over those 30 years.

Why the East started out so much lower

The separation between the West and East could not have been more fundamental and severe. Both parts of Germany were voluntarily or involuntarily heavily influenced by the United States and the Soviet Union, including their respective economic systems.

The political landscape of the Federal Republic of Germany (West Germany) was divided between proponents of the reunification of East and West and proponents of further integration of the FRG with the other countries of the west. That both the reunification and the west integration could not be realized at the same time resulted in the dependency of the FRG on the United States. At the time, the United States was in the midst of the cold war and had a large interest of containing the Soviet Union’s communism as much as possible (also referred to as Containment politics). If West Germany wanted to end the occupation regime of the western forces, it had to take a standpoint aligned to western interest. Konrad Adenauer, who was Chancellor at that time and in fact the first chancellor Germany ever had, therefore put high emphasis on the better alignment with the west [6]. The adaptations which followed included many cultural aspects but also the form of economy, namely a market economy.

In contrast to the West, East Germany could not count on large subsidies from its carrying superpower, the Soviet Union, quite to the contrary actually Not only did the Soviet Union not invest any amount in the economy of East Germany, it took out large amounts to make up for reparation costs [7]. As all member states of the Warsaw pact, East Germany had a command economy, or Planwirtschaft in German.

After elaborating on the historical context, it is now important to outline the large differences between a market economy and a command economy. A market economy builds on two fundamental aspects: private ownership, and voluntary exchanges and contracts. Which product is produced in which quantity is decided by the company itself, which uses estimated consumer preferences to decide production amounts. The equilibrium prices of goods are based on demand and supply, a process described by Adam Smith as the invisible hand [5]. It is to be said that there is not country which has a pure market economy. This is because oftentimes economic policies still regulate parts of the market to strengthen consumer rights. The economic model of the Federal Republic of Germany, which was also kept after the reunification is referred to as a social market economy. The German Ministry for Economic Affairs describers this type of economy as follows:

“the social market economy is the foundation of our liberal, open and democratic society. The main idea behind the social market economy is to protect the freedom of the economy and functioning competition, and at the same to foster prosperity and social security in our country.” Source: https://www.deutschland.de/en/topic/business/social-market-economy-in-germany-growth-and-prosperity

In a command economy, on the other hand, the government does all the planning of how many units of which product are produced via owning the means of production. Not only does this sound like an insanely difficult task, it also proved to be basically impossible in practice.

A high level of corruption, low level of efficiency and productivity, and the focus on industrial goods (around 90%) in a time when these goods where less in demand and more cheaply produced in Asia countries (Japan) led to the financial collapse of the command economy in the Soviet Union. By how much exactly the economy in the east was lagging the western economy, is visualized in the graph below.

The notable case of the state of Berlin

Even though Berlin is counted as an Eastern state within our analysis, it has to be said that this is not an obvious decision and might well be disputed. Berlin was, equally to the rest of Germany, geographically split by the Allies into a western and an eastern part. Therefore Berlin, even though located deep in the east of Germany, was partly under the authority of the western government.

The sudden alienation between east and west Berlin in 1948 took western forces by surprise, resulting in no electricity in many parts of west Berlin. Soon after west Berlin was cutoff from its geographical surroundings [11].

In order to supply the people in West Berlin with food and other supplies, the renowned Berlin airlift was put in place. Planes arrived every few minutes to West Berlin airports carrying all supplies needed by the population.

Source: https://en.wikipedia.org/wiki/History_of_Berlin#/media/File:C-54landingattemplehof.jpg

The tension between the East and West peaked in 1961, when East Germany began to build a wall which divided the eastern Berlin from western Berlin. This division ruled out the possibility of around 50.000 people from East Berlin to pursue their work in West Berlin, which subsequently greatly hurt the economic power of West Berlin.

During this time of geographic isolation, West Berlin could count on the help of Federal Republic of Germany, which also benefited from the Marshall plan. The goal of the Marshall plan was to improve the economic situation of western Europe and condemn the influence of the Soviet Union in Western Europe.

Given the help of Federal Republic of Germany to West Berlin, it makes Berlin as a whole difficult to compare to other states in the former East which did not have that level of economic support. It is therefore important to remember when looking at the upcoming analysis that Berlin’s performance is not completely representative for the economic performance of East Germany, even though it is counted as an eastern state.


Data and Methodology

The GDP per capita figures are taken from the website https://www.deutschlandinzahlen.de, which is a subsidiary of the German Economic Institute.

Given that all data is stated in nominal terms, which means that there are not inflation adjusted, we also imported German inflation data from Quandl, a world-renowned provider of financial and economic data.

In order to adjust for inflation we first divided the Consumer-Price-Index (CPI) by its level in 2019, before then dividing all nominal GDP per Capita figures by the result of the former calculation.

If we would for example have a CPI level of 70 in 1995 and a level of 120 in 2019, we would first calculate 70/120 = 0.5833. That would imply that the 10 Euros in 2019 have the same purchasing power than 5.83 in 1995. For a more elaborate explanation, we suggest reading this article of ours.

Overall Trend

Before moving into the cross-sectional analysis, where we look at figures for each state individually, we start with an overall analysis of the economic situation across the entire country. From the chart below we can see Box-plots of all German states in every year.

A box-plot is a tool from descriptive statistics for graphically depicting groups of numerical data by their quartiles. They are capable of showing five pieces of information, namely the minimum, maximum, the median (50th percentile), as well as the first quartile (25th percentile) and third quantile (75 percentile). Box-plots represent a great to get a feeling for the underlying distribution of the data.

The chart above contains several insights worth to pointing out. To begin with, we see that the Interquartile range (IQR), which describes the length of each box, decreases drastically in first couple of years. That means that the GDP per Capita for the States are brought more into line and closer to one another. After 1995, it seems though that there is not significant change visible.

Another notable observation is the positive development of the entire boxplot. Across all years, with the sole exception of the direct aftermath of the financial crisis in 2009, it looks like the box-plot as a whole is shifted upwards. This would indicate a systematic increase of GDP per Capita for all states in Germany. In order to test whether that effect also carries statistical significance, a linear regression is conducted. The results of this regression are shown below.

The significant positive coefficient of time (year_num) indicates that on average the GDP per Capita is rising by 318.29 Euros per year. This effect is shown to be significant, with a p-value below of the 5% hurdle. It is to be noted that we are looking at real GDP per Capita, and that these numbers are not simply a result of inflation.

Over Time and State

After seeing that we find an overall positive trend in GDP for all states, it would be now interesting to see how that development looks specifically each state in more detail. The heat-map below (tutorial for this chart can be found here) shows the development of GDP per Capita over the years.

In 1991 the dark blue in East Germany indicates the comparatively bad economic shape the East was in back then. Over the years, the stark color difference fades slowly but surely away, indicating the lower inequality between states.

In order to get a better feeling for magnitude, we also look at the dynamic bar-chart below. In order to better compare the Eastern and Western states, we colored all Western states in turquoise and the Eastern states in red.

The chart displays the economic dominance of the West. Next to Berlin, which cannot completely be referred to as a Eastern State, all Eastern states take the last places for all years.

Inequality Measure Over Time

In order to directly measure inequality, we apply different statistical measures, namely the Lorenz Curve and the Gini Coefficient.

The Lorenz curve is a graphical representation of a distribution and illustrates the magnitude of disparity within it. Oftentimes used to exemplify wealth or income inequality, it is used here to show the deviance to a world where every state would have the same GDP per Capita. Instead of displaying total wealth of a nation on the y-axis, how it is oftentimes done with a Lorenz curve, this presentation shows the cumulative GDP per Capita on the y-axis. Of course, the resulting summation does not carry any interpretable meaning, but it also does not have to have one. The sole purpose is to illustrate the level of inequlity over time.

Directly related to the Lorenz curve is the Gini-Coefficient which can be seen as a quantification of the Lorenz curve. More specifically, it measures the ratio between the diagonal and the Lorenz curve (blue-shaded area) to the entire area below the diagonal. The Gini-Coefficient will be therefore a number between 0 and 1, with higher numbers representing a higher inequality.

The chart below nicely shows how the blue-shaded area, and with it the Gini coefficient slowly decays over time. A clear sign of how the inequality in Germany reduces over time.

Awakening from a bad dream

The question might be asked why the East had and still has such a difficult time catching up with the West. One might think that thirty years of subsidy payments would help and that the East would benefit of the many sharp minds in all Germany. The sober truth looks different unfortunately and shows how difficult it is for an economy to redo a trend that was initiated through the division of Germany.

There are several reasons as to why the economic situations in the east and west were so varied. When the wall came down and the country reunified, the East was not able to control the movement of people anymore and lost a significant amount of their brightest and most productive people, people that are needed to make a nation economically prosperous. To assign a number to that phenomena: between 1991 and 2018, the East (without Berlin) saw a decrease in population of around two million people [10]. In contrast, West Germany plus Berlin gained more than five million.

The other reason, which might be very well the even bigger one, is the process of how companies in the East were privatized. The concept of private ownership had not previously existed in East Germany during the GDR, which was a communist state. Therefore, an agency referred to as Trust Agency (Treuhand in german) was put in charge of privatizing or closing of about 12,000 or more companies state-owned companies [8]. At the end of its work, every second company in the East was now in possession of the West [9]. These companies were responsible for around two thirds of the revenues of the East, which were now missing.

It is obvious that the aforementioned two reasons resemble a classical chicken and egg problem. With all productive workers leaving the East, it proves difficult to rebuild their economic wealth, yet without any well-run companies and high salaries, productive workers will continue to leave the East.

A solution does not come easy, with many politicians trying to appeal to prosperous and investment-willing companies to increase their present in East Germany [10].

Final Note

Looking back on the developments of the last thirty years, the numbers speak a clear language. The relative disparity became significantly lower over time. Looking at the chart below, we can see that in 2019 Eastern Germany had an average GDP per Capita level which represents 75% of the corresponding Western figure. It will probably take a lot longer before the disparity between the East and West completely vanishes. The eastern states were simply unlucky to have fallen into a zone which would turn out to be so damaging economically. It is now up to Germany to show unity and to reunify East and West also economically.

[1] McCauley, Martin (1998). Gorbachev. Profiles in Power. London and New York: Longman. ISBN 978–0582215979. [2] Deutsche Einheit — 100 Milliarden Euro fließen pro Jahr in den Osten. In: Welt Online. 21. August 2009, abgerufen am 31. Oktober 2009. [3] Werner Weidenfeld, Karl-Rudolf Korte (Hrsg.): Handbuch zur deutschen Einheit, 1949–1989–1999. Campus Verlag, 1999, S. 369. [4] https://www.bundesregierung.de/breg-de/aktuelles/solidaritaetszuschlag-1662388 [5]What is Invisible Hand? Definition of Invisible Hand, Invisible Hand …economictimes.indiatimes.com › definition › invisible-hand [6]https://www.geschichte-abitur.de/deutsche-teilung/westdeutschland [7] Berghoff, Hartmut; Balbier, Uta Andrea (2013). The East German economy, 1945–2010: falling behind or catching up?. Cambridge University Press. ISBN 978–1–107–03013–8. [8] https://www.bpb.de/geschichte/deutsche-einheit/zahlen-und-fakten-zur-deutschen-einheit/211280/das-vermoegen-der-ddr-und-die-privatisierung-durch-die-treuhand [9] https://www.sueddeutsche.de/wirtschaft/wiedervereinigung-florierende-ostfirmen-gingen-meist-an-westler-1.5034223 [10] https://www.welt.de/print/welt_kompakt/article195179199/Warum-der-Osten-nicht-mehr-aufholt.html [11] Ladd, Brian (1997). The Ghosts of Berlin: Confronting German History in the Urban Landscape. Chicago: University of Chicago Press. pp. 178–179. ISBN 978–0226467627.