From Reunification to Economic Integration: Productivity and Labor Markets in East Germany Michael Burda, Humboldt-Universität zu Berlin Universita Bocconi 18.March 2002

East Germany ten years after: Facts After fast start, growth has stalled Convergence is incomplete: –Consumption –Wages –Productivity per employed –Productivity per capita Unemployment rate is high, employment ratio low As a result, fiscal transfers are high

YearConsumptionNominal weekly wage Labor productivity GDP per capita Dimensions of Convergence, 1991 – 2000 (% of respective West German value)

YearConsumptionNominal weekly wage Labor productivity GDP per capita n.a. 2000n.a. Dimensions of Convergence, 1991 – 2000 (% of respective West German value)

YearConsumptionNominal weekly wage Labor productivity GDP per capita n.a n.a.73 Dimensions of Convergence, 1991 – 2000 (% of respective West German value)

YearConsumptionNominal weekly wage Labor productivity GDP per capita n.a n.a.73 Dimensions of Convergence, 1991 – 2000 (% of respective West German value)

YearConsumptionNominal weekly wage Labor productivity GDP per capita n.a n.a Dimensions of Convergence, 1991 – 2000 (% of respective West German value)

Convergence and Integration We focus on labor productivity growth and labor utilization Mechanisms of economic integration Back of the envelope: how much investment, how much migration? Depends on assumptions about technology

Convergence and Integration We focus on labor productivity growth and labor utilization Mechanisms of economic integration Back of the envelope: how much investment, how much migration? Depends on assumptions about technology

Accounting for the Labor Productivity Slowdown Not due to quantity of inputs

Land/Region Annual investment-GDP ratio, average, (%) Annual investment per capita, average, (DM, 1995 prices) Cumulative investment, , (bill. DM, 1995 prices) Equipment Structures Equipment Structures Equipment Structures All eastern States Memo: GDP, 2000 all eastern States All western states Memo: GDP 2000 all western States Investment Expenditures in Germany,

Accounting for Slowdown in Labor Productivity Convergence We construct estimates of states´capital stocks using various boundary conditions Strong evidence of a slowdown in total factor productivity (TFP) growth as measured by the Solow residual since 1995

All Eastern states All Western states Total Germany Growth in relative value- added deflator* Growth in value- added at 1995 prices* Growth due to inputs Solow Resid. Growth in relative value added deflator* Growth in value- added at 1995 prices* Growth due to inputs Solow Resid. Region Sources of Growth in Germany, (log points per annum)

All Eastern states All Western states Total Germany Growth in relative value- added deflator* Growth in value- added at 1995 prices* Growth due to inputs Solow Resid. Growth in relative value added deflator* Growth in value- added at 1995 prices* Growth due to inputs Solow Resid. Region Sources of Growth in Germany, (log points per annum)

Explanations of the slowdown in TFP growth since 1995 Not the quality of labor – there has been convergence of returns to skill Relative price effect (Ragnitz: 15-20%) Correcting for the cycle Infrastructure Firm size Composition effect

All Eastern States All Western States Total Germany State/Region Benchmark estimates from Table 8 Four age employment inputs Four population age classes Benchmark estimates from Table 8 Four age employment inputs Four ages classes for population Table 12. Alternative estimates of total factor productivity growth, (log points)

Utilization of Labor: Are labor markets in the East working? Microeconometric analysis confirms convergence in return to skill Relative improvement of Eastern women Inequality in East has now reached West levels Evidence on minimum wages is ambiguous How to reconcile unemployment and rigidities with dramatic deunionization in the East

Utilization of Labor: Are labor markets in the East working? Microeconometric analysis confirms convergence in return to skill Relative improvement of Eastern women Inequality in East has now reached West levels Evidence on minimum wages is ambiguous How to reconcile unemployment and rigidities with dramatic deunionization in the East

Mobility of Labor: Migration Cumulated migration high Low net flows belie large, heterogeneous gross flows (young out, old in) Econometric results on net and gross flows consistent with migration theory –Destination wages, unemployment matter –Source unemployment puzzling –Effects are age-sensitive Implications

Mobility of Labor: Migration Cumulated migration high Low net flows belie large, heterogeneous gross flows (young out, old in) Econometric results on net and gross flows consistent with migration theory –Destination wages, unemployment matter –Source unemployment puzzling –Effects are age-sensitive Implications

Summary Despite remarkable progress in the first half of 1990s, growth in eastern Germany has stalled The problem is not a lack of K: cumulated investment since 1991 roughly equals region´s cumulated current account deficit (  1.5 tril.DM) Sharp slowdown in TFP growth after 1995 is culprit Hard to explain at the individual level except for logarithmic constant

Summary Plausible explanations? –Slight composition effect resulting from migration –Infrastructure spending slowdown –By elimination, ´soft´ factors must matter Migration is powerful force for integration Supply or demand?

Update (March 2004) Counterveiling developments: –Collapsing construction sector –Growing manufacturing sector Also relative to the West

East in 2003 (1998=100) West in 2003 (1998=100)

Policy Recommendations Infrastructure investment in eastern Germany should continue Scrap most active labor market programs: take US evidence seriously! Spend savings on better job services and monitoring, EITC, or even wage subsidies Scale back investment tax subsidies (especially structures)