At first glance, Germany appears to have benefited extraordinarily from the
collapse of East European communism. With the accession of the German
Democratic Republic (GDR) to the .ederal Republic of Germany (.RG) on
3 October 1990, Germany was able to overcome one painful result of its
defeat in World War II: its split into two opposing parts along the front line
of the Cold War. Moreover, reunification seemed to promise that West
Germany would reinforce its already strong position among the worlds
leading economies.
But a few years after unification it became apparent that the event hurt
German economic performance more than it helped. .rom 1992 to 2002,
Germany experienced growth rates below its annual increases in
productivity, resulting in rising unemployment and the weakest economic
performance overall among the European Union countries. While economic
reform issues took centre-stage in the 1998 and 2002 German federal
election campaigns, the RedGreen government achieved little tangible
change. This was in large part due to the fact that the unification process had
contributed both to the worsening of Germanys economic performance and
to political stalemate over economic reform. .ailure to adapt to new
challenges does not protect the status quo. Rather, it is likely to make the
situation more painful.
In the process of unification, the transfer of Western political-economic
institutions to post-socialist Eastern Germany took place just at a time when
model Germany was beginning to lose its capacity to deliver favourable
economic outcomes, even in the Western heartland. To make matters worse,
West German institutions were imposed on a social and economic fabric
that lacked the organisational prerequisites to benefit from them. As a
consequence, the transfer of institutions to Eastern Germany accelerated the
crisis of the German model in the unified country.
German Unification and Model Germany:
An Adventure in Institutional Conservatism
HELMUT WIESENTHAL

This article addresses two questions. .irst, how and why did the process
of unification negatively affect the nations ability to sustain the German
model? Second, why have the problems and detrimental consequences of
institutional transfer nevertheless made it harder rather than easier to
reform key pillars of the model? This study will focus first on the
macroeconomic dynamics of East Germanys incorporation into the West.
The fact that these dynamics made it harder for Eastern Germany to create
microeconomic institutions and mechanisms like those in West Germany
that would be able to sustain economic growth is discussed in the second
section. .inally, Eastern German public opinion is opposed to any macro-
and microeconomic reforms that might get Germany out of its
predicament. The conclusion speculates that this leaves few options open
for serious reform.
THE MACROECONOMICS O. GERMAN UNI.ICATION
West Germany never relied on a counter-cyclical Keynesian fiscal policy,
and especially not on demand-side deficit spending during periods of
economic recession. The terms of unification, however, forced German
economic policy-making into precisely that pattern.
.our general conditions shaped  if not over-determined  a post-
socialist pathway of political-economic reform in the territory of the former
German Democratic Republic that was unlike any chosen by neighbouring
post-socialist countries. .irst, in terms of international security and power
relations, Western elites perceived a fleeting window of opportunity to seize
upon Gorbachevs willingness to trade the GDR in for a new era of co-
operation with the West. Asserting a primacy of politics over mundane
economic details, the Bonn government hurriedly closed a deal with the
four World War II allied powers to make rapid unification possible.
International security considerations caused the Kohl government to ignore
the warnings by leading economists and opposition leaders that the costs of
rapid unification would be very high. The speed of unification, in turn, left
little room for social experiments and required that existing institutions be
transferred to the new German Länder which had previously constituted the
German Democratic Republic.
Second, initial uncertainties about East German support for the rapid
absorption of the GDR into West Germany shaped the pathway of
unification. In the autumn of 1989, neither the East German civil rights
associations nor the small group of reformers within the Communist Party
that would later refashion itself as the Party of Democratic Socialism
GERMANY: BEYOND THE STABLE STATE38

(PDS) welcomed a capitalist system. Instead, they preferred a
modernised democratic socialist East Germany in an economic and
political confederation with West Germany. West German politicians were
able to overcome popular East German reservations by embedding
unification into the process of deepening European integration. They also
offered economic benefits to East Germans that would allow them to
rapidly approach the standard of living enjoyed by West Germans. In this
process, the memory of West Germanys miracle economy of the 1950s
and 1960s served as a helpful myth, even though the preconditions  such
as an undervalued currency or a rapidly expanding post-war world
economy  were manifestly missing in the early 1990s. The Eastern elites
principled aversion to unification was rendered ineffectual after the
unequivocal popular pro-unity vote in the last GDR legislative election on
18 March 1990.
Third, the rapid speed and external West German control of the
unification process came about as a result of the weakness of East German
civil society and of nascent post-communist politics after 40 years of
intense repression  which, since the 1960s, had not allowed dissidents to
organise themselves in ways comparable to Hungary, Poland or Slovenia.
Although some 20 East German civil action groups and organisations had
been founded in the autumn of 1989, they played only a minor role in
identifying and representing the citizens interests. As a consequence, the
Bonn government was able to drive forward the process of unification as
a transfer of West German institutions with virtually no serious opposition
 especially after the March elections had awarded the East German
affiliates of the major West German parties an overwhelming majority in
both the legislative and executive branches of the GDR government.
All aspects of reform  whether in the form of direct institutional adoption,
as a consequence of extensive bargaining, or as market-driven change1

thus boiled down to the external governance of unification by the West
German political and economic elite. However, this could only be made
palatable to the East Germans by granting them comprehensive economic
benefits and protection from the costs of economic and institutional
transformation.
.ourth, Western electoral and political-economic interests drove the
speed of the unification process. Only a high pace of unification would
guarantee the governing Christian DemocraticLiberal coalition
government the opportunity to time the all-German elections sufficiently
early to take advantage of the initial popular enthusiasm and optimism
before its costs and frictions could surface and lead to disenchantment.
39GERMAN UNI.ICATION AND MODEL GERMANY

Against the backdrop of these conditions, the implementation of
pluralist democracy and a market economy in East Germany and
the legal unification of the country occurred within the span of less than
one year. Economic, monetary and social union (EMSU) took effect in July
1990. This secured the transfer of West Germanys entire array of legal,
social and economic institutions and became the framework for all
subsequent regulations  in particular, the Unification Treaty, which
resulted in the GDRs formal accession to the .ederal Republic of
Germany.
Thus, from the very start, Eastern Germany benefited from a proven
and complete institutional system that included a legal framework, a
judicial system, administrative agencies and representational bodies.
Neither the political institutions of the market economy, the demarcation of
sub-national administrative jurisdictions and local self-government nor the
political-economic frameworks of social insurance, industrial relations and
economic interest representation had to be invented from scratch. In
addition to the transfer of institutions, the new Länder had the
extraordinary advantage of being able to draw on economic resources from
the formerly West German and now all-German public budgets and social
security funds.
In macroeconomic terms, the rapid integration of East Germany, with
comprehensive economic protection, compensation and improvement of the
populations living standards, combined an extreme economic shock
therapy with far-reaching insulation of the population from its
consequences  in other words, with an anti-shock policy. Currency reform
and privatisation were the shock element in the package. With the EMSU,
the East German Mark was made equivalent to the western Deutsche Mark
on a parity basis. Wages and transfer incomes were also fixed in a one-to-
one relationship. This amounted to an overnight appreciation of the local
currency by about 400 per cent, rendering almost all East German economic
activity instantly uncompetitive with western products and services.
Productivity levels in the east were estimated at only about 30 per cent of
western levels, and thus far too low to meet the new labour costs faced by
East German production units.
Although the purchasing power of the East Germans had quadrupled as
a consequence of currency reform, there was popular pressure for further
improvements. With the December 1990 all-German election approaching,
the federal government succumbed to the temptation to promise inter-
regional wage equalisation within five years, thus promoting unrealistic
popular aspirations. The federal government generated expectations that
GERMANY: BEYOND THE STABLE STATE40

later yielded an endemic problem of widespread popular dissatisfaction
with the material results of subsequent economic developments.
The costs of shock therapy combined with anti-shock guarantees
began to surface in the rapid tailspin of the East German economy that
occurred throughout the 1990s. Growing imports, financed by huge
income transfers from the west, caused the collapse of production in the
east as well as a dramatic rise in unemployment.2
Meanwhile, the newly
installed privatisation agency operated by West German restructuring
experts  the Treuhandanstalt  rapidly dismantled the state-owned
industrial conglomerates, gave them a legal corporate governance
framework, and weaned them off soft credits in order to prepare
them for privatisation. Many of these firms were forced to shrink
dramatically or had to go out of business before or after privatisation. Even
then, about half of the survivors had to be granted state subsidies for
restructuring and new investments, at least in the early years. Overall, the
gainfully employed labour force in Eastern Germany shrank from close to
ten million in 1989 to barely six million within a couple of years.
Employment in manufacturing nose-dived from close to 50 per cent of the
total to under 20 per cent, thus undoing 50 years of industrialisation in less
than three years.
The painful restructuring and shrinkage of the East German
economy were followed by a giddy surge, with growth rates of up to eight
per cent (from a low floor) in the 199295 period  mostly fuelled by a
giant building boom aided by western public investments in infrastructure
and residential renovation. But then, in the period between 1995 and 2000,
the structural weakness of the new Länder economy asserted itself
again, with sluggish growth rates of only about half of the already
modest western levels. In 2001, the eastern economy shrank by 0.5 per
cent. Even generous investment incentives had been unable to compensate
for the comparative disadvantage inflicted on the eastern economy by
EMSU. Because currency union had removed devaluation as an option to
restore eastern competitiveness, East German firms could not cover the
huge increase in wages and social contributions  which far exceeded
productivity  through price increases or reductions in the cost of
factor inputs.3
At the macroeconomic level, this produced extraordinarily
high unemployment and a need for ever-higher fiscal transfers from
West Germany, resulting in very large budget deficits. At the
microeconomic level, federal and state governments were compelled to
engage in industrial policy. The macro and microeconomic policies
adopted in response to the eastern crisis were inconsistent with the
41GERMAN UNI.ICATION AND MODEL GERMANY

practices that had traditionally been pursued under the auspices of the
German model.
Soon after unification, unemployment in the east grew to a level
twice as high as that of West Germany  not taking into account the
substantial share of the former East German labour force that was sent into
early retirement, had withdrawn from the labour market, or took part in
public retraining programmes. At almost 20 per cent from 1996 on (23 per
cent including hidden unemployment), East German rates exceeded
those of all Central European countries. This extreme unemployment 
resulting both from the wave of de-industrialisation and from higher labour
market participation among East German women  constitutes
Eastern Germanys basic political-economic problem. On the one hand, the
only proper way of improving the macroeconomic situation (technically
speaking) is through lower wages, lower tax rates and more flexibility
in the labour market and in state regulation. On the other hand, politicians
in both the east and the west are experiencing strong pressure to call
for the final closure of the remaining eastwest income gap of 15 per cent.
While Eastern German voters are demanding the full equalisation of all
living conditions, economically sound policies lack sufficient public
support. The much lamented consequences are the ongoing migration of
skilled younger people4
and more than one million unoccupied apartments
in the east.
In order to compensate for the extensive layoffs in industry and
agriculture, huge transfer payments were directed to the east. Popular
pressure demands that they continue until the GDP per capita approaches
the western level. Meanwhile, labour productivity has risen to 78 per cent
of the West German level but, due to high unemployment, eastern domestic
production per capita remains at only two-thirds of the western level.
Transfers and new debts of between 75 and 100 billion euros per annum
finance East Germanys high consumption. The borrowed share of East
Germanys prosperity thus amounts to one-third of the total of investment
and consumption. Cumulative total net financial transfers from the west
between 1990 and 2002 reached 800 billion euros.5
Much of this was
invested in subsidised employment  above all, in the still over-staffed
public sector.
One striking indicator of over-staffing is the proportion of wage income
to regional GDP. This amounts to 112 per cent of its western equivalent,
even though the average eastern individual wage is only 77 per cent of the
West German level.6
The most conspicuous consequence of East Germanys
sponsored prosperity is thus the escalation of public debt. As a percentage
GERMANY: BEYOND THE STABLE STATE42

of total GDP, Germanys state debt rose from 41.5 per cent in 1991 to 61.5
per cent in 1997. Correspondingly, interest payments increased from 11.4
per cent of the budget in 1991 to 18.9 per cent in 1999.7
In 2002 and 2003,
the federal government was unable to confine the budget shortfall to the
three per cent ceiling fixed in the EU Stability Pact. Since unification,
German macroeconomic policy has developed a propensity towards
persistent counter-cyclical deficit financing.
Is there no way out of this economic malaise? Now an integral part of
Germany, the new Länder lack autonomous macroeconomic control.
Because all the important variables are externally controlled, only regional
wage levels remain available for intervention. Early on in the unification
process, the suggestion that lower eastern wages would trigger migration to
the west helped legitimise the high-wage policy of (western-controlled)
trade unions and employers associations, although the underlying
presumption lacked empirical evidence.8
Since then, because of electoral
imperatives, parties and state governments have found it increasingly
difficult to resist the pressure for inter-regional wage equalisation.
Proposals to make wages match the low level of labour productivity
definitely seem unfeasible.9
In 2002, the re-elected RedGreen coalition
government promised a step-by-step equalisation of wages in the public
sector until 2007  of course, at the expense of the number of available
jobs.10
The Results of Unification  A Mixed Blessing
Comparing East Germanys present situation with the state of the late GDR,
one can easily see that the eastern economy has made tremendous progress.
Although the period of thoroughgoing restructuring at company level is
over, the economy as a whole continues to be subject to favourable
structural change due to high investments in infrastructure and human
capital. The share of its competitive sectors in the GDP keeps growing at the
expense of inefficient traditional sectors. .orces of employment growth
now appear to counterbalance those of decline. The number of firms going
out of business, on the one hand, appears to offset the number of new
investments on the other. But while a competitive economy is emerging, its
size is still too small given the volume of labour supply.
When we examine East Germany in comparative context, there is more
reason for satisfaction. Life has improved in almost every aspect, and far
more so than in such countries as Poland or the Czech Republic. But this
improvement does not translate into subjective satisfaction, because the
reference is West Germany, not other post-communist countries. Because of
43GERMAN UNI.ICATION AND MODEL GERMANY

their quest for full compensation, when real average incomes amount to
only 85 per cent of western levels, many East Germans feel they are being
treated as second-class citizens.
Even extraordinary levels of financial compensation for the departure
from a socialist economy did not protect the German federal government
from eastern discontent. Exuberant early West German promises about
eastwest equalisation, together with eastern ideological-cultural residues
of socialism and resentment against income differences, have combined to
turn most political issues into matters of social justice that make inter-
regional relations appear to be almost a class conflict between the rich and
the poor. Although post-unification dissatisfaction11
manifests itself
above all in injured self-esteem, its common denominator  as well as the
only feasible remedy  appears to be monetary. This constitutes the political
pole of a fundamental dilemma. Whereas the macroeconomic situation
demands patience and self-restraint on the part of the East Germans, the
political debate  in both the new and the old Länder  is subject to the logic
of party competition with its strong incentive to trigger unrealistic
expectations. All vote-seeking parties (including the liberal .DP) try to
benefit from the resulting dissatisfaction with the achieved levels of
distributive justice. Consequently, the governments of all five new Länder
remain strong advocates of continuing the sponsored eastern prosperity
achieved through resource transfer from West Germany for an indefinite
period of time.
THE MICROECONOMICS O. UNI.ICATION AND MODEL GERMANY
The operation of the West German model relied on labour market
institutions facilitating sectoral and national wage-bargaining concertation,
led by large companies, but compatible with the needs of most small and
medium sized enterprises. Such institutions were supplemented by
contribution-based social insurance systems configured around protecting
the standard of living of families supported by a single male breadwinner.
That arrangement fed back positively into the employment system. By
granting high levels of earnings-related compensation for labour market
risks such as unemployment, it encouraged workers to make human capital
investments in skills specifically valuable to a single industry or a single
employer  for example, through vocational education.
As other articles in this volume show, the conditions that supported these
arrangements have been eroded throughout Germany. But in East Germany
such conditions were absent from the beginning and could not be created
GERMANY: BEYOND THE STABLE STATE44

out of thin air by government in the 1990s. German unification therefore
hastened the nationwide erosion of the German model. This section
addresses the relevant issues one by one and then consider how federalism
 as a potential technique to dissociate policies in eastern and western states
 has helped or hindered efforts to address the unique problems of
unification.
Wage Concertation
In the era of post-war growth, industry-wide peak-level bargaining between
centralised employers representatives and union representatives succeeded
in organising a social class compromise. These negotiations resulted in the
moderation of nominal wage increases, peaceful and predictable industrial
relations for business and rising real wages for labour. The principal
beneficiaries of the compromise were the very large, export-oriented
German manufacturing companies that maintained high profitability and
international competitiveness by pegging sectoral wages to the average
conditions of firms in their sector. .urthermore, national wage leadership by
the most export-oriented metal engineering sector throughout much of the
post-war era ensured that unions and employers in the domestically oriented
sectors could not ratchet up wages in ways that would endanger the
international competitiveness of German business. Large firms also
accepted institutions of co-determination through factory-level works
councils and firm-level workforce representation on company supervisory
boards. Small and medium sized, mostly privately held businesses  an
important ingredient of the West German growth and export machine 
could swallow peak-level arrangements as long as domestic and
international markets kept growing and did not require them to respond to
tougher competitive environments with flexibility in the deployment of
capital and labour.
The system of industry-wide peak-level wage bargaining was extended
to East Germany just at the time when small and medium sized companies
felt increasingly hard-pressed to accommodate such agreements. Moreover,
East Germany lacked resourceful, large and profitable corporations in the
aftermath of the dramatic de-industrialisation effected by the shocks of
monetary union and privatisation under the Treuhandanstalts regime of
dismembering and down-sizing the old socialist holding companies and
selling off the remaining marginally viable but generally unprofitable bits.
Nonetheless, the first peak-level collective agreement negotiated by trade
unions and employers associations in 1991 resulted in a substantial wage
increase despite generally low labour productivity. Consequently, firms
45GERMAN UNI.ICATION AND MODEL GERMANY

either ignored the agreement or faced economic disaster. Although about 80
per cent of eastern enterprises  comprising almost 60 per cent of all wage
earners  ignored the wage settlement, it set the standard for what union
representatives advertised as fair remuneration.
Because of the collapse of industry-wide wage contracts in the east, the
unions began to tolerate firm-specific wage and working time agreements.
So-called opening and hardship clauses were introduced in collective
agreements to improve factor flexibility. Innovative experimentalism12
became a standard means of coping with the rigidities of supra-firm-level
collective agreements vis--vis the global competition.13
While tight
regulations were finally loosened in the west, belated institutional learning
had little impact on the much poorer economic situation in the east. A key
ingredient of model Germany could not develop firm roots in the new
Länder.
Wage Bargaining, Mittelstand and Industrial Policy
The institutional bias of German industrial wage bargaining in favour of
large firms became dysfunctional for another reason as well. As early as the
1980s, large companies changed from being centres of job creation and
instead became machines for high productivity growth through the insertion
of capital-intensive, labour-saving technology and subcontracting with
components manufacturers situated in low-wage countries. Innovative
technology, new products and the rapid rise of business-related and private
services fuelled a revival of small and medium sized enterprises
(Mittelstand). Centralised industrial relations did nothing to nurture the
take-off of small and medium sized companies in East Germany. Moreover,
the imposition of western regulatory codes on an economic landscape in
which only the massive creation of small companies could solve the
problem of unemployment stifled factor flexibility and the entrepreneurial
freedom required to stimulate the growth of small companies. While the
federal government attended to the fate of the large, run-down socialist
conglomerates, only a handful of members of parliament or representatives
of business associations were campaigning to bring about a Mittelstand-
friendly environment with effective incentives for venture capital and new
entrepreneurs.
De-industrialisation and the collective bargaining system stifled the
early emergence of a critical ingredient of the German system  an
infrastructure of intermeshed medium sized, competitive and export-
oriented businesses. This deviation from the German model led policy-
makers to adopt another deviation that reinforced economic rigidity and
GERMANY: BEYOND THE STABLE STATE46

failure to adapt to new challenges: a defensive interventionist industrial
policy. Expensive subsidies were paid to save as many jobs in the existing
industrial plants as possible. .ederal and state governments targeted
subsidies primarily to areas in the old cores of East German industry,
where the shock of monetary union and marketisation had created
particularly high unemployment. Because such policies consumed a large
share of the disposable financial industrial aid, regions with a higher
potential for growth in terms of human capital or infrastructure were left
with too few incentives to attract a large volume of investments.14
Clinging
to an outmoded concept of industrial policy, governments proved unable to
resist short-term labour market considerations. Thus, huge amounts of
investment capital, both public and private, were allocated in inefficient
ways.
The overall picture of state-subsidised investment is mixed at best. A
telling example is the reconstruction of the GDRs chemical industry
complex around the town of Bitterfeld. According to a promise made by
Chancellor Kohl, the equivalent of 25 billion euros from federal and EU
funds was marshalled to rebuild the run-down production sites. Several
billion were given to the .rench investor Elf-Aquitaine, which is said to
have redistributed a considerable share of the subsidy as bribes. A similar
subsidy went to Dow Chemical, on the order of no less than 1.2 million
euros for each of 1,800 jobs retained. Nonetheless, the unemployment rate
in the state of Saxony-Anhalt continues at 20 per cent. Another famous
case is the fate of the saved company Zeiss Jena, one of the few high-
tech firms of the former GDR. Instead of reconstructing the unprofitable
site, the companys CEO, Lothar Späth (a former minister-president of
Baden-Württemberg) dismantled the Jena-based workshop and stripped
away nearly all of its workforce. At the same time, almost two billion
euros in public subsidies were spent on the acquisition of already
profitable firms in West Germany.
Overall, during the first decade after unification, policy-makers paid
little attention to issues of structural reform, such as the creation of viable
medium sized businesses. Macroeconomic problems left little time for them
to consider microeconomic developments. The high debt generated by
German unification became entangled in the imperatives of reducing public
budgets in accordance with the Maastricht criteria for European Monetary
Union. Minimal attention was paid to reconsidering the financial and social
consequences of the unification process.
It was not until the mid-1990s that the debate over a renewal of
Germanys institutional order resurfaced. Even then, as other contributions
47GERMAN UNI.ICATION AND MODEL GERMANY

to this volume show, only meek initiatives were undertaken to revive
economic growth. Little attention was paid to the special structural
problems of East Germany. If anywhere, the accomplishments of reform
after 1998 were concentrated in the area of post-materialist issues such as
environmental sustainability, citizenship and minority rights  all areas in
which national rather than regional Eastern German constituencies guided
the calculations of politicians.
Managing Risk through Social Insurance
As a result of the rapid de-industrialisation in East Germany, full
coverage of its population by the same health care, pension and
unemployment entitlements as their western counterparts was bound to
lead to large revenue shortfalls. In order to pre-empt protests, the federal
government had refrained from using unification as an opportunity to
reform and retrench German social insurance benefits, and instead
extended full coverage to all East Germans. As an immediate
consequence, citizens in the east enjoyed a sudden increase in the quality
of services and the level of income transfers. Whereas in 1990, pensioners
in the east had received only 29 to 37 per cent of standard western
pension, levels had risen to 79 per cent five years later.15
Because benefit
disbursements raced ahead of payroll tax receipts, employees and
employers social security taxes had to be increased to 20.3 per cent of
gross wages in 1997.
In the health care system, an analogous rise in expenses was triggered
not only by the extension of benefits to East Germans, but also by
institutional transfer from West Germany. The East German Polikliniken,
with teams of salaried doctors working together in ambulatory care
facilities, were a comparatively cost-efficient form of managed care.
With Eastern German doctors split over whether to keep this system or
adopt the more expensive West German system of private medical
practice  and with the federal Minister of Health remaining apparently
neutral  the western doctors special interest associations succeeded in
extending the western system after carrying out a massive campaign
among East German doctors. Instead of leaving the issue to western
organised self-interest, the federal government could have strengthened its
own and the public health care funds position by adopting Polikliniken as
a managed care pillar of the German medical system. .ailure to do so
contributed to further cost escalation in the German health care system,
evidenced by an increase in payroll taxes for health insurance from 12.6
per cent in 1990 to 14.2 per cent in 2002.
GERMANY: BEYOND THE STABLE STATE48

The collapse of the East German labour market in the aftermath of the
currency shock contributed to deficits in the German welfare state, not only
due to a surge of early retirees that had been forced out of the labour market
and were compensated by generous pensions. There also was the drain of
East German unemployment benefits and retraining measures on the
German unemployment insurance system. Whereas many regard the overall
results of the publicly funded labour market policies as a crushing
disappointment,16
the payroll tax for unemployment insurance rose from
4.3 per cent in 1990 to 6.5 per cent in 1995.
As Leibfried and Obinger report in this volume, the cumulation of all
these expenses made German payroll taxes rise to record levels  from
35.6 per cent in 1990 to almost 42 per cent in 2002. The ensuing rise in
labour costs further hurt the competitiveness of German business. Eastern
Germans became beneficiaries of wage income replacement rates that had
been set in the early 1970s, at a time when the single wage-earner family
was still the norm. But in the 1990s, gainful employment by both men and
women was the norm in East Germany, even more so than in the west.
Hence, western benefits schemes translated into extremely high family
compensations and weakened incentives for the beneficiaries to re-enter
the labour market except for the lure of high wage rates. At the same time,
because of the significance of high compensation levels for a large
proportion of the East German population, any attempt at reducing their
generosity would be political suicide for vote-seeking politicians.
Nevertheless, it is clear that high payroll taxes and benefits drive up
German labour costs and undercut efforts to stimulate growth and
employment.17
Education System
Most citizens regarded the transfer of West German educational institutions
to the new Länder as a more or less self-evident matter and, consequently,
the issue did not gain much public attention. Of course, there were
occasional misgivings because of the continued employment of GDR
schoolteachers who were once required to display strong communist beliefs.
Apart from this, however, the new East German institutions of primary,
secondary and tertiary education replicate their western counterparts. Even
the old western controversy about the proper organisation of secondary
education  separated into three streams according to pupils differing
academic talents, or united as a comprehensive school for all children
regardless of abilities  was carried over into the east. The only exceptional
feature of eastern educational institutions remained the availability of
49GERMAN UNI.ICATION AND MODEL GERMANY

kindergarten places for nearly all pre-school-aged children. General
conformity to the western model can also be seen in the system of firm-
based and state-organised vocational training.
Although the transfer of the western education system to the east may
not be spectacular, it serves as yet another example of an area where the east
adopted institutions just as they ceased to be unambiguously advantageous
even in the west. Since 1990, signals indicating the declining performance
of Germanys secondary schools and its vocational training and university
systems have been frequent. Had it not been for the challenge of unification,
the weakening performance of the West German educational system would
have made it onto the political agenda earlier than it actually did, when the
process of imposing the old western education system on its socialist
alternative had finally come to an end.
Vocational education has long been a part of the German education
system which seemed particularly indispensable for the proper operation
of the German model. As Mayer and Hillmert indicate in this volume,
efforts have been made to expand the menu of vocational education to
include new occupations, but these efforts have been timid. Most of the
344 approved occupations are still defined by the sectoral and
technological structures of the past. Some aspects of the system were
already outmoded on the eve of unification. About two-thirds of all
apprentices are trained for occupations in the shrinking sectors of
manufacturing and Handwerk. At the same time, the system has failed to
match employers increasing demands for young people with broad basic
competencies and special training in information technology and
business-related services. Even East Germanys pressing need for jobs in
innovative and growing business sectors has not been enough to trigger an
adaptation of the system to its changing environment.
While the slow speed of reform in the system of vocational training
appears to be a by-product of meso-level corporatist decision-making, the
performance deficits attributed to German universities inability to train
students in new, highly marketable professions, long duration of degree
programmes and effective time to completion, mediocre research
productivity of university faculties stem from the interaction between the
fiscal and organisational interests of the Länder administrations in
governing their own university sectors and the self-interests of the
corporate groups involved in the university system: professors, students
and administrators. Limited self-governance on the part of the universities
keeps a system in place in which all groups block change in order to
preserve their entrenched privileges and material benefits. The Länder are
GERMANY: BEYOND THE STABLE STATE50

unwilling to give universities more autonomy and responsibility, keeping
control over admissions, faculty appointments, courses of study and
degree requirements. Corporate groups inside the university block any
change that would generate more competition for funds and status
recognition among students, professors, faculties and entire universities.
In turn, weak exposure of all of these groups to competition discourages
innovators who might propose new professional curricula or avenues of
research. Both the rewards for successful innovation and the punishments
for failure in the pursuit of excellence are ineffectual. Universities have
therefore seen little reason to adapt to the demands of external labour
markets.
The inefficacy of the university system became particularly manifest
when Chancellor Schröder came up with an unusual proposal. Since the
universities had failed to train a sufficient number of information
technology specialists, immigration laws should be relaxed to allow
software experts from India and elsewhere to fill the available jobs.
Although the debate on this subject was lively, consequences for the
reorganisation of higher education were slow in coming. Such changes tend
to be prompted by new Europe-wide agreements to organise higher
education more efficiently in order to improve the comparability and
equivalence of university certificates across Europe. Exactly the same slow
pace of reform may result from the debate that has followed Germanys
extremely low ranking in the Programme for International Student
Assessment (PISA), a comparative survey of the school achievements of
15-year-old pupils organised by the OECD.18
The causes of the education systems declining performance are well
known. They are representative of Germanys institutional conservatism,
which is rooted in the anti-competitive predilections of occupational
status groups as well as Länder governments. As Leibfried and Obinger
argue in this volume, the social democratic-Christian welfare state in
Germany has channelled funds away from the formation of new human
capital to the care of holders of spent human capital. In 1999, Germanys
overall public expenditures for education were slightly below the OECD
average at 4.35 per cent, although overall social expenditures were near
the top of the scale.
To make matters worse, the influence of occupational interest groups
and political parties over education policy has biased the structure of
expenditure and the educational governance regime away from the pursuit
of excellence. Only the upper stratum of secondary education and the
partly outmoded system of vocational training receive adequate funds
51GERMAN UNI.ICATION AND MODEL GERMANY

because they enjoy sufficient external business backing or the attention of
powerful status interests in the teaching profession. .urthermore, resource
allocation favours teachers and administrators salaries at the expense of
investments in buildings, teaching resources and media. The PISA survey
demonstrates that the lower stratum of secondary and the whole of primary
education are neglected both in funding and in management. As a result,
the education system fails to provide the economy with a sufficient number
of labour market entrants who are adequately prepared to thrive in a
knowledge economy.19
Not only the main political parties  which are
beholden to powerful corporate interests dominated by people who care
more about retirement and health care than about new human capital
formation  but also the Länder governments, in whose jurisdiction much
of educational reform would be located, lack the political incentives to
develop a long-term investment perspective for education. Instead, they
have treated educational and research budget lines as targets for fiscal
austerity measures.
.ederalism in Unified Germany
The logic of German federalism rests upon the notion of decentralised
multi-level decision-making. But rather than providing a national
framework for a market preserving federalism that enables sub-national
units to compete with each other to find the most productive and
democratically accepted innovative public policies, German co-operative
federalism prescribes a complex web of interdependent decision-
making that requires a broad consensus both at the national and the state
level in order to enact change. Thus, the system handicaps reform
initiatives emanating either from the centre or from the individual states.
German federalism fragments jurisdictions, but does not create autonomy
for bold initiatives. If innovation requires a consensual process involving
both the states and the federal government, then the smallest common
denominator among the many veto players determines the ceiling for
reform efforts.
Unification enhanced the fragmentation of sub-national geographic
jurisdictions in Germany. Although the GDRs new political elite had the
option of joining the .ederal Republic as a single additional Land, they
chose to re-found five rather small Länder with a total of 14.5 million
citizens that mirror the heterogeneous structure of the west. Germany now
has 11 Länder with less than three million citizens each. .urthermore, the
entry of the new states into the federation creates a new divide that cuts
across the existing partisan and regional divisions in the Bundesrat. Here,
GERMANY: BEYOND THE STABLE STATE52

majorities of the state governments can block federal policy initiatives in the
many social and economic policy areas for whose governance the
constitution prescribes co-operative federalism.
Co-operative federalism not only constrains the federal government but
diminishes its control over public budgets as well. In accordance with the
constitutional mandate to bring about equality of living conditions in the
federation,20
a substantial share of tax revenues is being redistributed from
the wealthier to the poorer states. Because of the resulting high level of
equalisation among individual state governments tax receipts
(Länderfinanzausgleich), the system has relieved the states from competing
with one another for a more attractive business environment or more
efficient public services. In particular, states and regions with aging
traditional industrial sectors are tempted to free-ride on the prosperity of
their luckier or pluckier neighbours.
.or the new Eastern German states, becoming equal partners in the
system of horizontal revenue redistribution in the mid-1990s has, therefore,
been a double-edged sword. On the one hand, the comparatively poor
eastern states gained access to badly needed resources they were unable to
acquire through taxes or loans. On the other hand, however, a permanent
role as recipients of other states financial largesse has suspended the need
for eastern state governments to reorganise social services and public
infrastructure in ways that match expenditures to internal revenues in the
foreseeable future. In fact, the eastern Länder are banding together to
preserve or extend the federal system of fiscal redistribution in their favour.
The resulting system of power-sharing in Germany creates a strong bias
in favour of the status quo21
 accompanied by fiscal irresponsibility at the
Land level, since sub-national jurisdictions are quite autonomous in their
debt management. As a consequence, the federal government is forced to
choose its fiscal policy within the boundaries of freedom left by the Länder
after they have chosen their policies. Cutting across all of this are the
political party interests of the Länder and federal governments. Since hardly
a year goes by when state elections do not take place  and the loss of state
election might impinge on the capacity of the federal government to
shepherd its legislation through the upper house of the parliament 
decision-making in the Bundesrat tends to generate not only fierce
geographically based distributional conflict but also partisan divides
motivated by state and federal politicians desire to win elections.
53GERMAN UNI.ICATION AND MODEL GERMANY

UNI.ICATION AND PUBLIC OPINION
Is public opinion potentially a force to counteract the political-economic
reform blockages in Germany that have been exacerbated by national
unification through the transfer of western institutions and the further
entrenchment of organised interests? In other words, could the intensified
crisis of Model Germany cause a shift in public opinion that would, in
turn, weaken the capacity of institutions and organised interests to resist
innovation? Empirical evidence suggests instead that unification shifted the
balance of public opinion towards more support for current German welfare
state policies as well as for the status of organised interests in policy
formation, especially that of the labour unions.
The achievement of unification after only a brief period of negotiations
was facilitated by the complementarity of two sets of interests. The western
elites interest in institutional continuity was a perfect match for the
easterners desire to swap the miserly socialist system of social security for
the much more generous welfare state of a leading OECD country. When
faced with the East German citizens expressed approval of an
encompassing and redistributive welfare system, the proponents of
unification refrained from retrenching and refashioning the existing
German welfare state. Surveys throughout the 1990s have illustrated that
underlying this social policy preference is a continued strong popular
support for the socialist concepts of equality and redistribution in East
Germany. Even seven years after unification, an 83 per cent majority of
Eastern Germans considered socialism a good idea if implemented
properly. When asked to choose between two basic values, no less than 75
per cent gave priority to the value of equality over the value of freedom.
During the same period, the explicit preference for a socialist-type
redistributive welfare state declined only slightly, from 76 per cent to 68
per cent. These figures put the Eastern Germans somewhat, though not
dramatically, ahead of West German public opinion. In a survey conducted
in the west in 1996, while only a 26 per cent minority of respondents
endorsed socialist values, here, too, 51 per cent preferred equality over
freedom. 61 per cent even identified socialism fully or rather as a good
idea that was carried out badly.22
Empirical evidence overwhelmingly indicates that the Eastern
Germans predominantly socialist sense of distributive justice translates
into extraordinary levels of support for the status quo of the German
welfare state. The organisation and experience of unification have
reinforced the normative bases of an unsustainable welfare state. The
federal government always faces a majority opposing social reforms and,
GERMANY: BEYOND THE STABLE STATE54

in particular, cuts in benefits. In 1997, when public budgets and social
insurance funds were already overburdened by financial transfers to the
east, a two-thirds majority of German citizens was reported to oppose any
change in existing entitlements. Only a tiny minority of 12 per cent in the
west and one per cent in the east was willing to accept cuts.23
A four-
country survey on welfare state reform conducted in March 2000 found
that Eastern Germans were the least willing to consider a reform of the
pay-as-you-go public pension system by inserting a funded component.
This response put the Eastern Germans support of the national status quo
slightly ahead of the Spanish support level, and more substantially ahead
of that of the .rench, Italian and West German respondents.24
East Germans
were also significantly more willing than West Germans to call for a further
extension of the welfare state through higher taxes.25
The accession of East
Germany thus broadened the majorities unwilling to consider far-reaching
social policy reforms.
Support for comprehensive redistributive social policies and support for
labour unions mutually reinforce each other. After having survived the mild
economic liberalism of the West German centre-right government in the
1980s without much harm, German unions managed to extend their domain
to the GDR even before unification. As strong supporters of the welfare
state status quo, of equal pay and of substantial expenditures on active
labour market policies, they soon won the broad acceptance of eastern blue-
and white-collar employees. Although union density has fallen steadily
since 1991, the unions have remained the unquestioned representative of the
eastern skilled full-time employees in traditional industries such as
manufacturing, construction and  above all  public administration and
social services.
The unions image as standard-bearers of the common good, combined
with the prevailing socialist conceptions of distributive justice in Eastern
Germany, effectively protected them from having to shoulder responsibility
for high levels of unemployment in the east and increasing unemployment
in the west. The unions successfully presented themselves as victims rather
than co-authors of the persistent labour market malaise. Their privileged
position in public opinion permitted them to act as defenders of the
institutional order and to reject concessions within the framework of a
proposed social pact to benefit the unemployed. The refusal of German
unions to make wage and social policy sacrifices for the sake of boosting
employment stands in contrast to union conduct in post-communist Eastern
Europe  as well as to that of unions in a number of European Union
countries that had to reduce public deficits in order to qualify for
55GERMAN UNI.ICATION AND MODEL GERMANY

participation in the European monetary union. Only in a climate of
intensifying public dismay about the state of German public finances,
further economic decline and the inability of the returning RedGreen
coalition to propose a comprehensive reform policy after the September
2002 election, did German labour unions began to rethink their position and
tolerate a labour market reform bill that passed the legislature in the winter
of 2002/3. But with the extension of the unreformed West German welfare
state to East Germany an accomplished fact, a full array of reforms will now
be much harder to engineer politically than it would have been ten years
earlier.
CONCLUSION
The international situation in 1989/90  together with the institutional and
electoral imperatives of the West German political elites  explains the
hurried and wholesale transfer of West German institutions to East Germany
during the unification process. With the benefit of hindsight, we can see that
this pattern of unification has contributed to the weakening performance of
the German political economy. Had international circumstances and
domestic power relations been different, the elites might have seized upon
unification as an opportunity to reform the basic parameters of the German
institutional fabric. Now, after the turn of the millennium, the political elites
find themselves in a situation in which this reform has become more urgent,
but also even harder to achieve.
The opportunity costs of sticking to the status quo are rising as well. Past
strategies for choosing a middle road between the Scandinavian social-
democratic welfare state and the Anglo-Saxon liberal residual welfare state
may now no longer be feasible.26
The accumulation of performance
problems  among them the generous extension of the western welfare state
to East Germany  may now call for a market-liberal retrenchment of
institutions and policies. But German political preferences and beliefs may
change slowly enough to make this a long-drawn-out incremental process.
In this situation, the proposal to shift policy jurisdictions to the Länder,
release them from the strictures of co-operative federalism and unleash
policy experimentation and innovation at the sub-national level is gaining
credibility. As long as path-breaking policy changes at the federal level are
unlikely, granting individual states the right to greater policy-making
autonomy might be a useful detour on the way to improved economic
performance.27
Needless to say, even this institutional change presupposes
an intensified sense of crisis among the population and the political elites 
GERMANY: BEYOND THE STABLE STATE56

one that makes them perceive doing nothing as more dangerous than
engaging in some modest experimentation.
NOTES
1. G. Lehmbruch, Institutional Change in the East German Transformation Process, German
Politics and Society 18/3 (2000), pp.1347; R. Czada and G. Lehmbruch (eds.),
Transformationspfade in Ostdeutschland (.rankfurt/New York: Campus 2000).
2. R. Pohl, The Macroeconomics of Transformation: The Case of East Germany, German
Politics and Society 18/3 (2000), pp.4893.
3. Pohl, The Macroeconomics of Transformation, p.51.
4. N. Werz, Abwanderung aus den neuen Bundesländern, Aus Politik und Zeitgeschichte
3940 (2001), pp.2331.
5. S. Bach and D. Vesper, .inanzpolitik und Wiedervereinigung  Bilanz nach 10 Jahren,
Vierteljahreshefte zur Wirtschaftsforschung 69/2 (2000), p.203.
6. IWH (Institut für Wirtschaftsforschung Halle), .ortschritte beim Aufbau Ost:
.orschungsbericht wissenschaftlicher .orschungsinstitute über die wirtschaftliche
Entwicklung in Ostdeutschland, Wirtschaft im Wandel 8/78 (2002), pp.182234.
7. Bach and Vesper, .inanzpolitik und Wiedervereinigung, p.204.
8. Empirical research revealed an opposite disposition among East German workers. See G.A.
Akerlof et al., East Germany in from the Cold: The Economic Aftermath of Currency
Union, Brooking Papers in Economic Activity 1 (1991), pp.187.
9. The factors contributing to low productivity include comparatively low supply prices, the
under-utilisation of capacities, a low capital intensity and  last but not least  over-
employment in certain sectors. See Pohl, The Macroeconomics of Transformation,
pp.6769.
10. According to Chapter III (Aufbau Ost) of the coalition agreement of 16 October 2002.
11. H. Wiesenthal, Post-Unification Dissatisfaction, or Why Are So Many East Germans
Unhappy with the New Political System?, German Politics 7/2 (1998), pp.130.
12. W. Jacoby and M. Behrens, Experimentalism as a Tool of Economic Innovation in
Germany, German Politics and Society 19/3 (2001), p.18.
13. As of 1996, almost half of the 120 largest German companies had made use of company-
level agreements with work councils and/or trade unions. Max-Planck-Institut für
Gesellschaftsforschung, Arbeitsbeziehungen in Deutschland (Köln: Max-Planck-Institut für
Gesellschaftsforschung 2002)
14. .. Barjak, Regional Disparities in Transition Economies: A Typology for East Germany and
Poland, Post-Communist Economies 13/3 (2001), pp.289311.
15. M.G. Schmidt, Sozialpolitik in Deutschland. Historische Entwicklung und internationaler
Vergleich (Opladen: Leske + Budrich 1998), p.141.
16. H. .eldmann, Labour Market Policies in Transition: Lessons from East Germany, Post-
Communist Economies 14/1 (2002), p.76.
17. P. Manow and E. Seils, Adjusting Badly: The German Welfare State, Structural Change, and
the Open Economy, in ..W. Scharpf and V.A. Schmidt (eds.), Welfare and Work in the Open
Economy, Vol.II: Diverse Responses to Common Challenges (Oxford: Oxford University
Press 2000), pp.264307.
18. German 15-year-old students rank 21st among 30 countries in terms of their capabilities in
reading, mathematics and science. OECD (ed.), Measuring Student Knowledge and Skills:
The PISA 2000 Assessment of Reading, Mathematical and Scientific Literacy (Paris 2000).
19. M.G. Schmidt, Warum Mittelmaß? Deutschlands Bildungsausgaben im internationalen
Vergleich, Politische Vierteljahresschrift 43/1 (2002), p.16.
20. Basic Law (Article 106-3, 2).
21. T. König, Bicameralism and Party Politics in Germany: An Empirical Social Choice
Analysis, Political Studies 49/3 (2001), pp.41137.
22. E. Roller, Erosion des sozialstaatlichen Konsenses und die Entstehung einer neuen
57GERMAN UNI.ICATION AND MODEL GERMANY

Konfliktlinie in Deutschland?, Aus Politik und Zeitgeschichte B2930 (2002), pp.1319;
R.I. Hofferbert and H.-D. Klingemann, Democracy and Its Discontents in Post-Wall
Germany, International Political Science Review 22/4 (2001), p.365.
23. R.H. Cox, The Social Construction of an Imperative: Why Welfare Reform Happened in
Denmark and the Netherlands but Not in Germany, World Politics 53/3 (2001), p.493; E.
Roller, Shrinking the Welfare State: Citizens Attitudes towards Cuts in Social Spending in
Germany in the 1990s, German Politics 8/1 (1999), p.26.
24. T. Boeri, A. Börsch-Supan and G. Tabellini, Would You Like to Shrink the Welfare State?
A Survey of European Citizens, Economic Policy (April 2001), Table 10, p.28.
25. Ibid., Table 13, p.33.
26. M.G. Schmidt, Still on the Middle Way? Germanys Political Economy at the Beginning of
the Twenty-.irst Century, German Politics 10/3 (2001), pp.112.
27. ..W. Scharpf, Mehr .reiheit für die Bundesländer, .rankfurter Allgemeine Zeitung, 7 April
2001, p.15.
GERMANY: BEYOND THE STABLE STATE58