Germany: The Big Merger

At first, as Frank Sinatra used to sing, they had high hopes — pie-in-the- sky hopes. After 40 years as the poor relatives, the East Germans were going to be welcomed into the big house. Following decades of yearning for the good life, as they had seen it nightly on West German television, 16 million East Germans would be inside the supermarket with real money in their pockets. In the country’s first-ever free election last March, people acted not only on the principle of one man, one vote, but also for one mark, one mark. Last Sunday, when monetary union between the two parts of the country took effect, they began to collect.

The shopping spree had actually started months earlier. East Germans moved beyond the oranges and bananas, so popular when the Wall first came down, to consumer electronics and cars. Everywhere, new brand names began to beckon: Panasonic, Miele, Zanussi. Magdeburg became Marlboro country. The West German chain Spar opened a supermarket 40 km east of the border and stocked it with Western goods. East Berlin got its Benetton.

Yet with DM-day come and gone, the mood is uneasy. While West Germans fret over the blank check they have signed, East Germans fear that before they enter the earthly paradise, they may have to pass through a purgatory of inflation and unemployment. They are also concerned that they may prove to be easy pickings for predatory Westerners, or Wessis in G.D.R. parlance. Certainly, the Wessis are coming. Hotels are packed with Western businessmen eager to cut deals, whether the object of desire is a state-owned company, retail floor space, or a summer home on the Baltic.

Inflation worries arise because state subsidies in the G.D.R. kept many prices artificially low. Rent and the costs of basic foods and public transport typically were a fraction of those in West Germany — less than one- fifteenth in the case of rent. On the other hand, consumer durables were outrageously overpriced — and an open market will bring them down.

East Germans earn less than half the average West German wage, and the 1-to- 1 money conversion, the key part of the economic-union agreement, does nothing to alter that. In part, this is rough justice. Productivity in the G.D.R. is perhaps only a third of West Germany’s, so employers will be paying less but also will be getting less.

For nearly a half-century, East German workers have held lifetime jobs in companies that had only to meet production goals, without much concern for costs, quality or innovation. The madness in this method is symbolized by the Trabant, the plastic-enclosed, four-wheel motorcycle posing as a small car. Until last November, customers waited up to 15 years for the privilege of buying one for then 22,000 ostmarks, or about $4,000; currently, the Trabant cannot be sold at any price.

Other G.D.R. industries have their Trabants in the form of outdated TVs, shoddy appliances and suits like Khrushchev wore. These unattractive wares now compete with Western goods; before July 1, across the East, prices were being slashed to fire-sale levels to unload old inventory before the full wave of Western goods arrived. If pent-up demand goes mainly to line the pockets of Western suppliers, G.D.R. producers, without financial reserves or adequate credit, will lack the cash flow needed to meet deutsche mark payrolls. Says Claudia Wormann, an analyst with the Inner-German Economic Policy Committee of the Federation of German Industry: “During the first months, enterprises will be living from hand to mouth.”

Unemployment is inevitable, and estimates range from a few hundred thousand people to as many as 3 million — a third of the work force. Klaus Reichenbach, a senior East German official, reckons that 15% to 20% of all companies are doomed, and the remainder will certainly have major layoffs. So far, the impact has been modest. Industrial output has fallen 4.5%, and only 100,000 people have registered as unemployed.

Things would be different if East German enterprises could get help from the deep pockets of a Western partner; thus a fierce mating dance is going on. Each day brings news of deals or rumors of deals, and sometimes it seems as if the G.D.R. is about to become a wholly owned subsidiary of Western business. For the moment, however, many takeover bids are hanging in midair because Western firms can still hold only a 49% share in an Eastern firm. Similar uncertainty surrounds the purchase of property. As Volkswagen chairman Carl Hahn puts it, “people are flying blind.”

By contrast, no limits are put on joint ventures not involving a transfer of ownership, and nearly a thousand have been announced. The biggest are in the auto industry: VW and the builder of the Trabant; General Motors and the manufacturer of the Wartburg; and Daimler-Benz and the G.D.R.’s sole truckmaker. These deals can provide a quick supply of salable products and produce needed cash flow.

Automobiles could be the engine of East German economic recovery. Certainly the demand is there. In a country where people waited a dozen years to buy a car, it is a triumph of tenacity that half the households own one. Since virtually all those car owners want to replace their Trabants and Wartburgs with real cars, estimates of potential sales range from 200,000 a year up to 700,000.

GM plans a new assembly plant outside Eisenach to produce 150,000 cars a year by 1993. Executives of Opel, the firm’s German subsidiary, do not cite a figure, but the investment will be more than $100 million. Opel managers see Eisenach as a part of their European network, so production is not earmarked solely for the G.D.R.

By and large, Western companies are not counting on East Germany’s remaining a low-wage country forever, and they are planning to put in their best technology. Thus, over time, East Germany could become something of a technological showcase. Says Opel management board member Horst Borghs: “It’s the nature of the business. Your newest plant is always your best.” Opel’s newest will be in Eisenach.

If a sudden influx of bankers is an encouraging sign, the East has cause to hope. Anyone entering the lobby of a luxury hotel there these days is greeted by an array of signs proclaiming the presence of representative offices of well-known Western banks. Those in East Berlin’s Grand Hotel include the WestLB, Algemene Bank Nederland, Bayerische Landesbank and Salomon Brothers. Peter Dahne, WestLB’s representative for the G.D.R., has set up offices in seven other G.D.R. cities, and will soon move into permanent quarters with a < staff of around 50, drawn initially from WestLB’s West German employees. Says Dahne: “We expect to face the same competition here as in West Germany.” That appears likely. Deutsche Bank will be opening 100 branches together with an East German partner. Dresdner Bank, which quickly set up an office in the city where it got its name, is expanding under the motto “Back to the Future.”

Eastern companies that find no single Western partner must eventually seek individual shareholders, either among their own employees or the general population. Ideas have been floated to distribute shares in former state-owned companies to citizens in the form of mutual-fund certificates. At present, ownership of these companies is in limbo, or rather in the hands of a state trustee body, the Treuhandanstalt.

Some enterprises, like the manufacturing of the Trabant, are probably unsalable at any price. They may include major polluters like chemical companies and lignite mines. The outdated state steel company faces a bleak future since its products typically cost three times West German prices. The outlook for agriculture is also grim since farm prices in the G.D.R. are above even the inflated European Community level.

Not all is gloom, however. VEB Polygraph is a remarkable success story — a sort of Katarina Witt of East German industry. The five principal enterprises of this former state conglomerate — Planeta, Plamag, Zirkon, Brehmer and Perfecta-will now be run separately. All make sophisticated printing equipment, and all are international leaders in their fields. Some other machine and machine-tool companies get good marks from Western bankers, including the Fritz Heckert plant in Chemnitz and parts of the October 7 group like the Niles gear-grinding machine company that had its origins in Niles, Ohio. The list of the tigers, though, is far shorter than the list of the dogs.

Administering the kiss of life to many of East Germany’s industrial behemoths will be a daunting task. Reviving small business should be easier because the area had a long tradition of smaller, specialized industrial companies before the command economy crushed them. It was only in 1972 that a final wave of nationalization swept the last 12,000 firms into state conglomerates. About half of them have already demanded to be reprivatized. Officials in Bonn and Berlin hope the spark of entrepreneurial talent can be rekindled with loans from European Recovery Program funds. Demand is high. An initial allocation of $3.5 billion has already been handed out, and a replenishment of the pot is planned.

Retailing is a classic small business in the Western world and should become so again in East Germany. Despite the best efforts of the Communists to squeeze out the last private retailers, 17,000 were still in business when the Wall fell. Many of them are eager to expand. West German suppliers, keen to see a viable network of small retailers, are advancing goods on credit and helping in other ways like donating old cash registers and display cases. The threat to the independent East German retailer is no longer the bureaucrat but the competing capitalist.

While East Germany faces enormous change, the impact of monetary union on West Germany is likely to be modest. The economic Anschluss adds 25% to the population but only around 10% to the gross national product. The conversion of marks adds about the same amount to the West German money supply. If spent, the freshly minted DMs will have the same effect on growth as a sizable tax cut. When this new demand hits a West German economy operating close to capacity, the Bundesbank will be keeping a wary eye on developments. Bundesbank president Karl Otto Pohl calls the 1-to-1 conversion “a generous offer that went to the limit of what is economically acceptable.” But he believes inflation can be contained.

The consensus of economists is that union will add around 1% to West Germany’s current yearly inflation rate of 2.5% and enough additional stimulus to keep annual growth around 4%. Interest rates will probably be higher than they otherwise would have been, although Friedel Neuber, chairman of the WestLB bank says, “East Germany’s capital requirements don’t necessarily need to result in higher interest rates.” West Germany, a major capital-exporting country, last year shipped about $60 billion abroad. A diversion of a fraction of that to East Germany would meet most immediate needs. Meantime, the addition of a large, lower-paid work force should slow wage rises in West Germany and boost profits.

The big unknown in the equation is the amount of direct aid that West German taxpayers will have to pay out to prop up the East’s economy. Figures as high as $60 billion a year over the next few years have been mooted; the DIW economic forecasting institute in West Berlin expects $30 billion annually. Bonn has already put together a war chest of about $70 billion for & eventualities. Among other things, Bonn inherits a large G.D.R. budget deficit and foreign currency debt of around $13 billion. At the same time, the special aid to West Berlin that West Germany provided, some $12 billion a year, can be phased out, and defense spending may be reduced.

Everything depends on how the East German economy responds to a free-market jump start. Pohl points out that “no one can subsidize uneconomic jobs in the G.D.R. forever.” Elmar Pieroth, a prominent West Berlin politician and businessman who advises the G.D.R government, insists, “The spirit of entrepreneurship is reappearing, and people are eager to take advantage of the possibilities.” That was the kind of spirit that created the Wirtschaftswunder.