The Soviet policies of dismantling industries and establishing a command economy in the German Democratic Republic (GDR) (East Germany) in the late 1940s compared to the expansion of free market, capitalistic system in the Federal Republic of Germany (FDR) (West Germany) provides an interesting case study of the relationship between political, societal, and economic environments in socialist and capitalist economic systems. The transition in economic systems that took place in Eastern Germany after the unification also shows how fluid economic systems change over time, and how these changes have long-lasting consequences on the societies. This article examines the economic, political, and social history of the German Democratic Republic (GDR) and the Federal Republic of Germany before and since German unification in 1990.

Historical Context of the German Democratic Republic (GDR) and the Federal Republic of Germany (FRG): 1945-1949

Before the end of World War II, the Allies had already drawn up victory plans to divide Germany into administrative occupational zones. These plans were finalized in the Potsdam Agreement in 1945. As seen in Figure 1, the American zone consisted of Bremen, Southwest Berlin, and a large portion of Southeast Germany. The British zone was comprised of West-Central Berlin and Norwest Germany. The French administered Northwest Berlin and Southwest Germany. Meanwhile, the Soviet Union retained administration over Eastern Berlin and Eastern Germany, including the provinces of Saxony, Saxon-Anhalt, Thuringia, Brandenburg, and Mecklenburg. In 1949, the British, American, and French zones, known as the Trizone, became the Federal Republic of Germany (FRG). Later that year, the Soviet Zone became the German Democratic Republic (GDR). This set the stage for a two-country region that would last until German unification in 1990.

In 1939, approximately 25% of the German population lived in the Soviet Zone. By the end of 1946, the Soviet Zone had a population of approximately 18.4 million (28% of total population), compared to 46.5 million in the combined Trizone regions.[1] By 1991, however, the percentage of Germans living in the eastern part of the country would drop to 22% of the entire population.[2] During the aftermath of World War II, millions of ethnic Germans displaced by the war returned to Germany. Between 1946 and 1950 over 20 million Germans were forced to leave Soviet controlled Poland.[3] While displaced persons were returning to their previous homes, the hope of a single-state German solution was fading.

One of the main challenges faced by both zones during this early two-state period was the abrupt ending of intra-German trade in 1948.[4] In 1936, 45% of all purchases within Germany were domestic purchases between German territories.[5] Both eastern Germany and western Germany were dependent on each other for their respective economic growth.  In 1949, however, the GDR’s acting government began to monopolize all foreign trade and to issue embargoes on western goods. The FRG, in turn, reciprocated by prohibiting trade from the GDR. These trade tensions between the Germanies led each country to rely on their allies for imports of necessary goods until intra-German trade was restored following the Berlin Agreement of 1971[6].

Historically, heavy manufacturing in eastern Germany was dependent on the importation of coal and pig iron from the western and southern regions of Germany. A decrease in coal production and trade embargoes with western Germany, in turn, was detrimental to East German industries in the years following the Potsdam Agreement. As a result, industrial output from eastern Germany fell from DM 7.7 billion to DM 5.8 billion between 1936 and 1950.

At the Yalta Conference in 1945, the allies agreed that each of the occupation powers would be allowed to settle reparations within their own administrative zones. Soviet reparations in East Germany took the form of dismantling plants and equipment. Within three years, Soviet troops dismantled and removed over 3,400 factories. As such, the total amount of reparations paid by the Soviet zone by 1953 was estimated at over $14 Billion.[7]Although reparations from western allies also took a toll on the economy in western Germany, Figure 2 shows the disproportionately higher impact of reparations per person in the Soviet zone.[8]

 While dismantling was a large part of the Soviet reparation policy, the Soviets were also interested in building an industrial capacity that would engender economic growth for the Soviet Union. The uranium industry in Saxony and Thuringia, for example, was specifically targeted by the Soviet Union.

In addition to reconstruction efforts centered around reparations, different economic and social institutions were also created in the two Germanies.  In the Trizone, western allies facilitated the implementation of a mixed-market economy through the promotion of property rights and free markets. In contrast, in the East, institutions were created within the framework of a centrally planned economic system. The Socialist Unity Party of Germany (SED), which would control the GDR government following the end of Soviet administration in 1949, created a state monopoly over production planning.

One of the major concerns in western Germany was the reemergence of inflation following the war. In 1946, the Colm-Dodge-Goldsmith-plan became the first plan aimed to reduce inflation in western Germany. The plan called for the reestablishment of a functioning price mechanism, reduction in the amount of money in circulation, and the establishment of a central bank.[9] In 1948, the creation of the new D-Mark came to fruition. In the Soviet Zone, the ostmark was also established and set to trade with the D-Mark on a one-to-one basis. The introduction of separate currencies and monetary systems further served to increase the division between the East and the West.

With the creation of the FRG and GDR in 1949, the stage was set for a two-country region that would last until unification in 1990. The FRG adopted a constitutional democracy and an open market, while the GDR adopted a more autocratic, parliamentary democracy, and a socialistic, command market economy.

History of Economic Systems and Institutions: 1949-1990

• West German Structural Development

In the Federal Republic, economic institutions were created with the aim of achieving pre-war levels of growth. With assistance from the United States through the Marshall Plan, West Germany received $1.4 billion of the $15 billion invested in western Europe as part of the Plan. The stimulus provided through the Marshall plan, in turn, helped rebuild the economy. It also changed the workforce in profound ways. Between 1950 and 1960, over six million jobs were added to the West German economy.[10] To fill many of the employment positions, guest workers came as refugees from East Germany, or through bilateral guest work programs with southern European countries, including Italy, Spain, and Greece. These contracts were extended to workers in Turkey in 1961. By 1989, Turkish workers comprised nearly one-third of all guest workers in the FRG.[11] Guest workers often worked in labor-intensive industries such as textiles, metallurgy, and services. By 1965, nearly 1.2 million workers in the Federal Republic were participants in the guest worker programs.[12]The FRG benefited from the unskilled labor needed to facilitate an economic recovery, and then eventually to send guest workers back to their home countries. Between 1950 and 1960, per capita gross national product in the FRG rose at an average of 6.3% per year.

Labor demographics were not the only big changes brought about during the post-war economic recovery in West Germany. Industrial changes were also widespread. From1960 to 1975, for instance, the number of workers engaged in the agricultural industry dropped by nearly two-thirds. Even though the work force shifted away from agricultural production, agricultural output increased by nearly 60%. Additionally, the coal industry, which constituted 70% of energy consumption in the FRG, decreased to only 20% of energy consumption within the same 15-year time frame.[13] Despite the change in workplace demographics and industrial focus, aggregate economic growth led to favorable conditions across all sectors. Advancements in technology allowed for increased efficiency and freed up agricultural labor for other industrial sectors.

Economic growth across sectors and social classes and the resulting political stability allowed the FRG to become a major global exporter. In the 1950s, the FRG’s exports accounted for 7% of total free-world trade; by 1964, this share rose to a little more than 10%.[14] Trade with the GDR and other socialist countries, however, remained low, accounting for only 2% and 3% of the Federal Republic’s total global trade, respectively. In contrast, the GDR and other socialist countries tended to focus on trade with other socialist countries such as The People’s Republic of China, Albania, Bulgaria, Poland, and Hungary through participation in the Council for Mutual Economic Assistance (COMECON). Here, economic development was based on an idea of an international socialist division of labor.[15] COMECON allowed the GDR to find other sources of raw materials and goods that were necessary for their industrial production from sources other than the FRG.

By 1958, the Federal Republic’s gross domestic product reached its pre-war level of $400 billion, and industrial output had quadrupled since the end of the war. Many dubbed this speedy recovery, the Wirtschaftswunder or “economic miracle.” Institutions destroyed by the war were rebuilt and helped West Germany to its pre-war levels of growth.

• East German Structural Development

The Soviet Union relinquished political control in East Germany to the Socialist Unity Party of Germany (SED) in 1949, leading to the creation of the German Democratic Republic (GDR). Structural economic changes were underway well before this pivotal moment, however. The German Economic Commission was founded by the Soviet Military Administration in 1947 to facilitate the formation of a centrally planned economic system. The Commission worked to perfect rationing systems and incentive controls. The goal was to create an economic system in which a state monopoly on trade and centrally planned production levels would lead to an equitable and stable economic system, free of market failures and externalities. To achieve this, prices, wages, supply, and demand were controlled by the central planning authority. In the late 1940’s, however, price freezes and a lack of information flow between central planners and industry made it difficult for the Commission to set clear economic goals. The result was that economic goals became politically defined and enforced by the SED.[16]

One of the first steps in establishing the planned economy was the processes of denazification and property reform. In accordance with the 1946 land referendum, over 2.1 million hectares of land were expropriated from the Nazis and war criminals and redistributed to nearly 200,000 self-employed farmers, workers, and expellees from the war who were returning to Germany.[17]The redistribution of this land was expected to provide its new owners a livelihood, and the country with a stable supply of food. In practice, the effects of Soviet dismantling meant that workers were left with inefficient supplies of agricultural equipment and livestock.[18]The government nevertheless continued to demand higher agricultural production levels that many farmers could not meet. With the government’s legitimacy at stake, coercive methods were often adopted as part of their incentive scheme. Such coercive methods, however, acted as a double-edged-sword. On one hand, they posed a threat for the state’s legitimacy because they were not a positive form of incentivizing production, and on the other hand, they reduced economic performance. Facing the prospect of penal repercussions, many workers fled the GDR, and those who stayed were often impoverished. The government’s policies also took a toll on the supply of raw materials and led to deteriorating infrastructure and declines in economic productivity.[19]

A lack of information flows between industries and the central planning authorities also led to a deterioration of economic performance. Unlike a free market economy, in the GDR economy, supply and demand were fixed in advance so that prices would remain predictable. Enterprises were given incentives, such as government subsidies, if they met the planned supply levels. As such, producers often set their production levels at lower levels. To ensure this, enterprises often underreported their inventory levels and hoarded coveted equipment, materials, and human capital so that supply goals could be met.[20] This resulted in wastefulness, inefficiencies, and a decline in economic quality.

The SED believed that through total planning, these issues would eventually resolve themselves over time. In light of the difficulties of the early Two-Year Plan (1949-1950), central planners began to focus on long-term aspirations through their Five-Year plans of 1951-1955 and 1956-1960. These plans focused on developing heavy industry, such as machine production and metallurgy. Beginning in the 1950s, however, the government began to prioritize technological development.[21] More than 50% of industrial development funds were allocated towards the chemical industry.[22]Most funded research went to the development of energy technologies. While some advances were made, over-investment in chemical engineering strained the resources available for other industries, and the economy continued to trail behind that of the Federal Republic. As a result, many young professionals and highly skilled workers fled the GDR to find better work and living conditions in the FRG.

To curb the human capital flight, the GDR in 1961 began to build a wall to separate East and West Berlin. The wall led to political turmoil and threats from the West to terminate intra-German trade. Realizing a change in control was necessary, the SED announced the “New Economic System of Planning and Management of the Economy” in 1963.[23] The goal of the plan was to modernize the economy and make it a competitive alternative to western capitalism. Economic incentives were provided to help align the interests of enterprises with the government, and enterprises were given more control in medium-term planning and budgeting mechanisms.[24]Domestically, these new freedoms led businesses to demand greater amounts of new resources for production. Equipment and other resources were often misallocated, and economic inefficiencies persisted. Meanwhile, the GDR’s main trading partner, the Soviet Union, began to face its own economic challenges. As a result, raw material deliveries that fueled the East German economy began to decline. By the end of the 1960s, despite these challenges, the program began to see some modest results. Increased investments in technology and the introduction of new government-funded projects led to a steady rise in industry growth rates and economic productivity. Incomes began to rise, and the standard of living improved.[25]

Between 1960 and 1980, the GDR began its contract worker program in an effort to fill jobs left vacant by workers who fled to the FRG. These three-year contracts were made with other socialist countries such as Vietnam, Mozambique, Angola, and Cuba. These workers faced discrimination and harsh living conditions.[26] Often, contract workers were forced to live in single-sex dormitories where social interactions were limited. Sexual relations were also prohibited, and women who became pregnant were forced to return to their home countries or have an abortion. At the time of unification, there were around 95,000 contract workers in East Germany, 60,000 of whom were from Vietnam.[27]

In 1970, the worker revolutions in Poland made eastern countries such as the GDR shift their economic and social focus toward public appeasement.  The Polish protests stemmed from an increase in food prices without an increase in wages.[28] Under Erich Honecker’s leadership, the SED tried to improve the standard of living by stabilizing supplies and prices, and increasing social welfare benefits offered to workers.[29] While social programs did increase the standard of living in the GDR, they also increased public debt. The global increases in interest rates in the late 1970’s, combined with the dramatic increase in the price of crude oil and other raw materials, sent the GDR into a debt crisis.

The debt crisis of the early 1980’s was exacerbated by the structural rigidity of the command economy. Government revenues were spread thin between technological investment, consumption-oriented industry, and debt service to the West.[30] As a result, productivity in the GDR fell to below 33% of the levels in the Federal Republic.[31] In 1989, the legitimacy of the SED was called into question. These economic, social, and political hardships, combined with the flight of refugees and mass protests, led to the collapse of SED rule and, ultimately, the fall of the Berlin Wall.

Post-Unification Convergence

The fall of the Berlin Wall led to the transformation of economic structures in East Germany. As central planning authorities lost control of distribution channels, enterprises experienced shortages of supplies and materials. Western D-Marks began to flood the economy in East Germany, and the GDR’s currency collapsed. Under the new non-socialist government, public land and enterprises were privatized, with nearly 22% of such enterprises being sold to West German investors.[32]These investors believed that their companies could meet the consumer demand of the combined economies. However, they kept most of their businesses in western Germany where most of the skilled labor fled from the East. Additionally, nearly one-third of the eastern firms were liquidated, resulting in the loss of 60% of the number of jobs that were available before privatization efforts.[33]

As a result of these privatization efforts, eastern Germany’s unemployment level rose from 15% in 1990 to over 20% by the end of the decade, and disposable income levels equaled only about 80% of that of western Germany at the end of 1990. As a result, the unification process led to increases of external investments and aid from western to eastern Germany.  By 2010, transfers to eastern Germany provinces totaled 1.2 trillion Euros.[34]

 Figure 3 shows the per capita GDP of eastern and western Germany in years after unification.[35] As shown, GDP per capita of eastern Germany has not converged with the west, indicating that the material wealth per person in the east remains significantly lower than that in the west.

GDP, however, is not the only indicator of standard of living and quality of life. The life expectancy for both women and men in eastern Germany has nearly converged with that of western Germany.  The life expectancies of people in eastern Germany have risen to 6.7 years since 1995. In addition to life expectancy, the consumption of various durable goods in the east has also converged with that of the west, and the consumption of luxury goods such as microwaves, dishwashers, and cell phones has increased since unification.[36]

Because transfer payments primarily affect the demand side of markets, it is also important to look at the factors that affect aggregate supply. These factors include unemployment and worker productivity measures. Figure 4 shows the number of unemployed people as a percentage of total population.[37] While the percentage of the population that is unemployed has converged in the recent years, the unemployment rate is still higher in the East.

 Among those who are employed, underemployment tends to be a problem in eastern Germany.[38] Stemming from privatization efforts in the wake of unification, most capital-intensive industries have remained in western Germany. As a result, skilled workers continuously leave the east to find work in the west according to their skillsets. Given the high number of highly skilled workers in the east and the low number of skilled labor jobs available, eastern Germany continues to experience a human capital flight. With the exception of retirees over the age of 65, eastern Germans have continuously emigrated to western Germany[39] From 1999 to 2003, an annual average of 84,000 eastern Germans between the ages of 18 and 30 have emigrated from eastern to western Germany each year, with those who stayed in the east often underemployed.

Summary

Post-war geopolitics and the military positioning of the Soviet Union in Eastern European countries posed challenges to the formation of economic systems in both the GDR and FRG.  The GDR, under Soviet influence, adopted a socialist economy in the hopes of eliminating the negative social impacts of potential market failures resulting from a capitalistic system.[40] The FRG, on the other hand, instituted a market economy. The central planning authority of the GDR relied on the subordination of economic policy to political systems and institutions in the name of creating a more humane and equitable economic and social environment. All economic decisions were the result of political planning processes. A combination of poor information flows to the central planning authority and the conflict of interest in the political-economic goals of the SED made it difficult for the government to set up an effective plan to move East Germany to a communist state.[41] In contrast, the FRG saw a speedy recovery and a quadrupling of its production since the end of the war—Wirtschaftswunder.  

After reunification, capital fled from eastern Germany to western Germany, with the East becoming increasingly less capital intensive. As a result, the unification process favored western Germany. Highly skilled labor, in turn, moved from eastern Germany to the West, with the remaining jobs in the East often going to underemployed workers, hurting productivity in eastern Germany.  Although productivity today lags in eastern Germany, emigration and transfer payments have improved the quality of life and the standard of living.

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