Ten Years After German Reunification

NOVEMBER 18, 2002

SPECIAL REPORT -- EUROPE'S FUTURE
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|Online Extra: Enlargement, through a German Lens |
|Overeager EU expansionists would do well to look atGerman reunification's mixed results over the last 12 years |
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In 1999, the euro started life at $1.17, its supporters full of high hopes that Europe's economy would be a rival to U.S. dominance. Four years later, the currencywallows below parity with the dollar, reflecting the lack of progress in the European Union's promised economic and market reforms. Without improvement on this front, costly plans for an even bigger Europe could do more harm to the euro -- and the Continent's economy -- than good.

Monetary union was expected to be a catalyst for reforms that would encourage foreign investment in Europe, whilecreating larger, more liquid markets to absorb the increased demand for euro assets. But the euro's chronic weakness against the dollar has been a result of investment flowing out of Europe and into the U.S. More restrictive and costly labor markets, relatively high inflation, and sluggish growth have turned investors off. Progress on improving European competitiveness is unlikely to speed up when 10emerging-market economies join EU.

A CONTINUED DRAG. While observers debate the impact of the new East European members, the experience of German reunification, involving the integration of a developed economy with a post-communist one, could be useful in shedding light on the likely costs of enlargement. West Germany was Europe's growth engine, and rejoining with its eastern counterpart madethe country the Continent's largest economy.

Although more than a decade has passed since reunification, it continues to be a drag on the German economy, which is currently Europe's weakest. Unemployment remains a very high 20% in eastern Germany. For the country as a whole, it hovers around a stubborn 10%, only briefly dipping below this during the late-'90s economic boom. The jobless rate,along with a lack of demand in the East, has cost the German government dearly: Berlin has transfered about 500 billion euros to the East over the past decade to pay for public services.

MMS International forecasts that the German economy will grow at a tepid 0.2% annual rate in 2002, compared with estimates for 0.8% growth in the euro zone as a whole (and vs. a 3.1% forecast for the "struggling"U.S. economy). Berlin has gone from being the model of fiscal rectitude to one of a growing number of EMU members violating government-spending limits set out in the very Growth & Stability Pact it helped engineer.

BICKERING CLUB. With the German example in mind, it's not surprising that observers turn a wary eye on the EU's plan to add 10 poorer economies to a bickering club of 11. Though thepolitical will exists to move ahead with EU enlargement, the thorny and complex issues of how to pay for it remain unresolved. That's business as usual, since European officials have enough trouble resolving their existing problems, with central bankers and politicians continuously blaming each other for a stagnant economy.

European budgets, like Germany's after reunification, are going to takea hit. Already straining to keep below limits set out in the Growth & Stability Pact, an EMU cornerstone, budgets will be stretched even further by the costs of integrating 10 poorer and less developed economies.

Supporters of expansion point out that this assimilation will be more gradual than Germany's experience. Economic development in the new EU members will have progressed much further...