Is Europe's economic giant sputtering?

• Author: Weidenbaum, Murray
• Position: The World Today

GERMANY IN THE YEAR 2007 is an economic paradox. On the one hand, it clearly is an affluent and technologically advanced nation. It is the fifth largest economy in the world and the biggest in Europe. Its gross domestic product of 2.8 trillion dollars in 2005 substantially was greater than that of any of its traditional rivals, such as the United Kingdom and France. Germany's GDP for the year was almost four times that of Russia, more than l0 times Poland's, and over 20 times that of the Czech Republic. Similarly, the country's population of 84,000,000 clearly is the largest in the European Union.

On the other hand, in recent years, Germany has become a laggard. Over the past four years, its economy has been growing much more slowly than Great Britain, France, or even the average for the other members of the European Union--and has a growth rate less than one-third that of the U.S. Surely, German industry suddenly has not become less efficient nor its workers lazy or dumb, and no natural disaster has destroyed any major part of the country's economy. The main reason for the slowdown has more to do with shortcomings in political rather than in economic decisionmaking. In 1990. East and West Germany were reunited after being split apart at the end of World War II. Many people expected that this long-anticipated achievement would give the nation an economic shot in the arm. On the contrary, the integration (including the necessary modernization) of the East German economy has been a continuous and costly long-term process. In good measure, that is due to the fact that. in 1990. the political leadership of the West German government made an extremely important decision without considering its many economic repercussions. Specifically, they decided to put the weak East currency on equal footing with the very strong West German Deutsche Mark.

The initial political attractiveness of this move was strong. It was touted as the economic unification of East and West Germany. As a practical matter, however, the unified currency meant that East German prices quickly would become equal to those of West Germany even though the efficiency of the East German economy remained much lower. Who now would want to buy a high-priced--but low-quality--automobile made in East Germany if a high-quality West German car was available for the same price? The response was swift, Much of the suddenly high cost but relatively inefficient industries in the eastern region were closed down. The entire East German economic base became too high priced to be competitive. Many workers were laid off and unemployment rose sharply.

The much wealthier and economically stronger West German government had little choice but to make massive capital investments in East Germany in order to maintain a minimum flow of income and a reasonable level of employment. Those huge and largely unanticipated outlays weighed down the overall Germany economy, substantially reducing its growth rate. The national government now provides about $70,000,000,000 a year to the still lagging "new provinces" (or neuer lander) that formerly were in the Soviet zone. As of May 2006, the unemployment rate in East Germany was 17.5%, almost double the rate of West Germany's 9.3%.

Nevertheless, substantial progress has been made in "East" Germany since the Berlin Wall fell. Moreover, we should not overlook the economic jewels that have been located in that region for some time. For example, the Zeiss optical factory in Jena had, and continues to keep, world-class scientists in its laboratories. General Motors states that its major automobile producing plant in the eastern sector is one of the company's most productive.

In retrospect, we should not forget that a key motivation for the Soviets building the Berlin Wall was to prevent the exodus of the most technologically and economically advanced people in the Soviet Bloc. Nevertheless, the communist system did a great deal of damage to the East German economy. It will take many years to achieve a complete recovery.

In addition, what economists call structural rigidities in Germany's labor market have slowed down the pace of economic activity. They have made it tougher for German industry to adjust to unexpected shocks and changes, notably low-cost competition from Eastern Europe and Asia. For example, strict regulations make it...