Long Road To Economic Reunification

Economist Ufuk Akcigit on why East German productivity still lags behind the West, what GDR and Treuhand data reveal – and what policymakers can do to help close the gap

More than 35 years after German reunification, a substantial economic gap between East and West remains. In 2019, economist Ufuk Akcigit received the Max Planck-Humboldt Research Award to investigate why the two regions have not fully converged. Together with researchers at the Halle Institute for Economic Research (IWH), he has examined the role of innovation, firm dynamics and the privatisation of East German companies in shaping the divide. His research draws on extensive microdata, including records from the former GDR and the Treuhandanstalt, to trace how economic structures and policy decisions continue to affect productivity today.

Professor Akcigit, why does the economic gap between East and West Germany persist more than 35 years after reunification?

Reunification changed East Germany’s political and economic institutions almost overnight. But it could not transform its productive capabilities at the same speed. You can introduce markets quickly; building competitive firms, technologies, managerial know-how, supplier networks and innovation ecosystems takes much longer. Today, productivity in the East is still more than 20 per cent lower than in the West. Our research suggests that the reasons reach back beyond reunification itself. They lie partly in the economic structures inherited from the GDR and partly in the way the transition to a market economy was managed after 1990.

How can such a development be studied over several decades?

Our project examines this development across three periods: the planned economy of the GDR, the privatisation of state-owned companies by the Treuhandanstalt, and the subsequent development of firms in reunified Germany. We conducted a massive data-mining exercise, digitising and standardising previously difficult-to-access firm-level data from the GDR and combining them with Treuhand contracts and post-reunification data on firms, products and ownership. This allows us to look at the privatisation process in great detail. For each company, for instance, we can see under what conditions it was privatised, who was in charge and who eventually bought it. We can then trace how these decisions affected companies and productivity over several decades.

And what does this long-term perspective reveal?

Economic structures turn out to be highly persistent. Under central planning, productive firms had limited scope to expand, unproductive firms were rarely forced to exit, and incentives to innovate were weak. After reunification, policymakers also faced enormous pressure to preserve employment and social stability. Some of the policies adopted in response protected jobs in the short run, but they also slowed the movement of workers and capital toward more productive firms.

There were other reinforcing forces as well. The migration of skilled workers from East to West weakened local knowledge spillovers, while scientific research in the East was not translated into patents and commercial innovation as effectively as in the West. Reunification removed the physical and institutional border, but it could not immediately erase differences in firms, capabilities, human capital and innovation networks. Those differences accumulated over decades-and rebuilding them can also take decades.

How did the GDR’s planned economy contribute to the productivity gap?

One important mechanism is what economists call creative destruction: in a market economy, new firms enter the market, successful and productive companies expand, while less productive ones shrink or disappear. Workers and capital can consequently move towards more productive uses. This mechanism was largely suppressed in the GDR. Comprehensive firm-level data show that entry and exit of firms, job reallocation and the growth of young companies were far less pronounced in planned economies than in market economies. Productive firms had little opportunity to expand, while unproductive ones generally remained in operation. The planning system also weakened incentives to innovate. When a company exceeded its production target, planners subsequently raised its targets. We find that by the 1980s this so-called ratchet effect had greatly reduced the incentive to improve productivity.

Does that mean the GDR simply lacked skilled workers or good scientists?

Not at all. The problem was systemic: the economic system did not reward experimentation, allow successful firms to scale, or redirect resources away from unsuccessful activities. Knowledge and technical ability were therefore less likely to be transformed into productive companies and commercially valuable innovations. Our model-based counterfactuals illustrate the magnitude of these effects. Had firms in planned economies been allowed to respond more strongly to productivity differences (i.e., had there been greater entry, exit and reallocation) annual productivity growth could have been approximately 1.8 percentage points higher. The GDR therefore entered reunification not simply with older factories or inferior equipment, but with an economic structure that had impeded the accumulation of productive firms and capabilities over many years.

What role did the Treuhandanstalt’s employment commitments play after reunification?

After reunification, Germany faced an enormous political and economic challenge: millions of jobs were at risk as former state-owned enterprises were exposed to market competition. When the Treuhandanstalt privatised companies, contracts therefore frequently included commitments to maintain or create a certain number of jobs. More than 18,000 such employment commitments are documented in the Treuhand archive.

Our research shows that these commitments worked in one important respect: they did preserve and create employment. Firms facing binding targets increased employment substantially. They did not simply hire cheaper or less-skilled workers. Instead, some increased patenting, expanded their management capacity and recruited employees with experience in West Germany.

That sounds like a success at first. So what was the problem?

Opening the economy produced immediate productivity gains, but it also exposed East German firms to competition from much stronger Western companies. Faced with the resulting threat to employment, policymakers required many privatised firms to maintain a specified number of jobs. These commitments reduced unemployment in the short run, but they came with a trade-off: by limiting the movement of workers and resources from less productive to more productive firms, they also slowed productivity growth. The comparison between Trabant and BMW captures the underlying dilemma: supporting Trabant could preserve production and employment, but it could not automatically give the company BMW’s technology, capabilities or incentives. Model calculations suggest that an alternative policy prioritising productivity-enhancing investment would have produced stronger and more lasting productivity gains.

What surprised you most when analysing the Treuhand data?

What surprised me most was that some inefficient firms were forced to grow rather than shrink. My field is economic growth and productivity, and what I teach is that inefficient firms should shrink while more productive firms grow and absorb their workers. I sometimes compare an economy to an accordion: it produces sound because it expands and contracts. An economy also needs this movement. But in the Treuhand data, I saw the opposite: firms facing binding employment targets grew by around 30 per cent on average.

One striking result is how strongly the employment commitments actually influenced companies’ decisions. Firms were about 6.5 times more likely to employ exactly the number of workers specified in their contracts than would otherwise have been expected. This indicates that the targets were not merely promises on paper but actively constrained firms’ behaviour.

What surprised you about the privatisation process itself?

One of the most striking findings concerns the involvement of West German companies in the privatisation process itself. The Treuhandanstalt had to privatise more than 10,000 enterprises with only around 200 agents, so it asked West German companies to second managers through the so-called “one-dollar manager” programme. This helped address an immediate shortage of expertise, but it also created a serious conflict of interest: managers connected to companies that could eventually compete with East German firms were helping to determine those firms’ futures. In the data, we repeatedly find that the companies providing these managers subsequently received preferential deals. This was not merely a question of fairness. By influencing which firms survived, who acquired them and how markets were structured, these arrangements may also have weakened long-run competition and productivity.

Taken together, these findings show that the Treuhand did far more than transfer ownership from the state to private hands: the design of the privatisation process shaped both decisions within firms and the competitive structure of the emerging market economy for decades to come.

What role does innovation play in closing the gap?

Innovation is crucial. East and West Germany are much closer when we compare scientific publications per capita than when we look at patents. This suggests that the problem is not simply a lack of research, but that scientific knowledge is not translated into technologies and commercial applications as effectively in the East as in the West.

What could policymakers do to help close the remaining gap?

There is no single policy that can close the East-West productivity gap. The first step is to recognise that this is primarily a productivity problem, not simply an employment problem. That changes the question policymakers should ask: not how to preserve as many existing jobs as possible, but how to enable productive firms and new technologies to develop and grow.

But before deciding on specific policies, we need a precise diagnosis. You would not go to a doctor with a headache and expect them to prescribe a drug simply because it worked for the previous patient. The same applies to an economy. We need high-quality microdata to understand which sectors and firms are doing well and where the bottlenecks are. There is no silver bullet for a problem that has developed over decades.

What would that mean in practice for East Germany?

One priority is technology transfer. East German firms could be supported in adopting and licensing existing technologies rather than being expected to innovate at the technological frontier immediately. Building technological capabilities first can enable firms to develop their own innovations later.

Another priority is to bring research and industry closer together and to build stronger innovation hubs that bring together universities, entrepreneurs, companies, investors and skilled workers. Berlin is an exception, but in much of East Germany this critical mass is still missing. The gap took decades to build. Closing it will take patience, precise diagnosis – and the political will to prioritise productivity over preservation.

Interview by Petra Maaß