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

2. 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

3. YearConsumptionNominal weekly wage Labor productivity GDP per capita 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Dimensions of Convergence, 1991 – 2000 (% of respective West German value)

4. YearConsumptionNominal weekly wage Labor productivity GDP per capita 199143 199254 199365 199470 199573 199672 199773 199873 1999n.a. 2000n.a. Dimensions of Convergence, 1991 – 2000 (% of respective West German value)

5. YearConsumptionNominal weekly wage Labor productivity GDP per capita 19914350 19925465 19936571 19947072 19957374 199672 19977376 19987376 1999n.a.76 2000n.a.73 Dimensions of Convergence, 1991 – 2000 (% of respective West German value)

6. YearConsumptionNominal weekly wage Labor productivity GDP per capita 1991435044 1992546557 1993657167 1994707270 1995737471 199672 1997737672 1998737672 1999n.a.7672 2000n.a.73 Dimensions of Convergence, 1991 – 2000 (% of respective West German value)

7. YearConsumptionNominal weekly wage Labor productivity GDP per capita 199143504442 199254655750 199365716759 199470727064 199573747166 199672 67 199773767267 199873767266 1999n.a.767266 2000n.a.73 65 Dimensions of Convergence, 1991 – 2000 (% of respective West German value)

9. 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

11. 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

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

13. Land/Region Annual investment-GDP ratio, average, 1991-98 (%) Annual investment per capita, average, 1991-98 (DM, 1995 prices) Cumulative investment, 1991-98, (bill. DM, 1995 prices) Equipment Structures Equipment Structures Equipment Structures All eastern States 13.228.3 35627745 503.61094.4 Memo: GDP, 2000 all eastern States 544.5 All western states 9.3 12.4 4063 5424 2071.5 2766.5 Memo: GDP 2000 all western States3120.7 Investment Expenditures in Germany, 1991-1998

14. 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

15. All Eastern states 3.26.82.44.4 All Western states -0.40.5 0.0 Total Germany 0.01.40.50.9 1992-1995 1996-1999 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, 1992-99 (log points per annum)

16. All Eastern states 3.26.82.44.4-0.11.22.0-0.8 All Western states -0.40.5 0.0 1.90.81.1 Total Germany 0.01.40.50.90.01.80.9 1992-1995 1996-1999 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, 1992-99 (log points per annum)

17. 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

18. All Eastern States 4.44.32.2-0.8-0.6-1.6 All Western States 0.0-0.5-0.81.10.91.0 Total Germany 0.90.5-0.20.90.80.7 State/Region 1992-1995 1996-1999 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, 1992-1999 (log points)

19. 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

22. 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

25. 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

27. 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

29. 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

30. 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?

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

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

33. 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)