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Infrastructure as Stimulus? German Reunification


Two weeks ago - I had to work all last weekend! - the example of the Athens Olympics was used to demonstrate the notion that "stimulus spending" - which typically reduces to nothing more than spending for spending's sake - can't lead to a sustainable economic recovery.  The example of the Athens Olympics is relatively small - the total spending associated with the Olympic venues didn't amount to much more than $11-billion.  A much better example is provided by the stimulus spending in the former East Germany following Germany reunification in 1990.  Indeed, in 2010, the twentieth anniversary of German reunification, prompted a considerable amount of reflection on what reunification had wrought.  It was noted that in spite of nearly $1.3-trillion euros - about $1.7-trillion at the time - in government stimulus spending over the last twenty years, including hundreds of billions on infrastructure spending, the former East Germany still badly lagged behind the west by almost every meaningful statistical measure. (1)

The former East Germany had approximately 18-million citizens.  It is then a simple matter of arithmetic to divide the post-unification stimulus spending, $1.7-trillion, by both the number of citizens, 18-million, and the number of years these stimulus payments were made, 20, to arrive at some very interesting conclusions.  The arithmetic shows that just over $4,700 per year in stimulus payments were made for every man, woman and child living in the former East Germany.  To put this figure into perspective, if a stimulus program of similar scope and ambition was enacted in the United States, population 320-million, the annual stimulus would be just over $1.5-trillion!  The total spending over twenty-years would then be $30-trillion!  At this point, most fair-minded people would be forced to concede the fact that if stimulus spending of this magnitude in East Germany was insufficient to put the former East German economy on a self-sustaining and self-sufficient path of growth, then no amount of public works spending could be expected to extract any economy from a recession.

To be sure, the former East Germany had a variety of problems.  The most significant of these was the result of a purely political but economic ruinous decision by Helmut Kohl, then the chancellor of Germany.  In direct opposition to the recommendation of his economic advisors and Karl Otto Pohl, the head of the Bundesbank, Kohl had East German marks exchanged one for one with much more valuable West German marks. (2)  Like Montagu Norman and Winston Churchill re-establishing the British pound to its lofty pre-war standard on a fictitious and fraudulent basis in April 1925, (3), Kohl's currency decision would have far reaching economic consequences. 

Kohl's advisors and Pohl understood the crucial importance of a country having a sound currency based in actual, productive capacity, (something undermined by stimulus spending funded by debt).   They recognized that high wages paid in a highly valuable currency could only be paid if the workers were highly productive.  They understood that workers in eastern Germany - after nearly 5-decades of communism and socialism - were not productive enough to be paid as much as their west German counterparts.  The high unemployment that plagued East Germany after reunification was the inevitable consequence of the fact that the output of East German workers was low relative to the wages they are paid.  (This is exactly what happened in the UK after England re-established the pound to its pre-war parity with gold in 1925).  Companies looking to expand their operations in the former East Germany soon realized they would be better off to pay for higher productivity in western Germany or to look further east into Eastern Europe, where East German levels of productivity were available at much lower wages. 

Helmut Kohl's decision to exchange east German and west German marks on a 1:1 basis notwithstanding, the "East German Experiment" provides fairly compelling evidence that 'stimulus spending' generally or 'infrastructure spending' more specifically can't spark self-sustaining and broad-based economic growth.  Of course, as with any spending program there will be beneficiaries of all the extra spending.  However, the gains enjoyed by these beneficiaries don't compensate for the costs that are borne by the rest of society - misallocation of labor and capital, increased circulation of money without a commensurate increase in goods to purchase and the cronyism that massive government spending programs always produce. 

As part of their education, mechanical engineers study thermodynamics, essentially energy and its manifestation in all its different forms.  One of the tenets upon which the entire field of thermodynamics is built is the concept that a perpetual motion machine can't exist.  If such a machine could be built, then once started it would continue to produce more energy than it consumes.  In one fell swoop, a perpetual motion machine would solve the most vexing problem faced by humanity - how to produce all the energy needed to sustain modern life.  However, because of thermodynamics and the rigor used to develop it, only crackpots, not serious engineers or scientists, seek to invent a perpetual motion machine.  In sharp contrast, the economic equivalent of the perpetual motion machine - the self-sustaining growth sparked by stimulus spending  - is regularly advanced as an antidote to any number of maladies an national economy might suffer from.  The fascination economists have with the merits of 'stimulus spending' is another example of how the field of economics pales in comparison to the hard sciences, and how the chief practitioners of economics are often difficult to distinguish from carnival barkers and hucksters..  



Peter Schmidt
November 01, 2020
Sugar Land, TX

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1.  Alexander Neubacher and Michael Sauga, "Germany's Disappointing Reunification: How East Germany was Lost," Spiegel International Online, July 01, 2010

2. Angel Merkel was a protege of Kohl's.  In many similar instances, Merkel's judgment has proven just as bad as that of Kohl, her mentor.