Real adjustment in a union of incompletely converged economies: An example from East and West Germany

Economic and monetary reunification in Germany has proved to be more expensive than previously thought - and not just for the Germans. If a 'Mezzogiorno problem' of continuing fiscal transfers to the East, and possible migration flows west, are to be avoided, then there has to be convergence in productivity levels. This paper analyses possible convergence paths, and the policy regimes which accelerate convergence. The intention is to illustrate the problems facing a European monetary union of asymmetric and incompletely converged economies. We find that convergence is likely to be slow: perhaps 30-40 years in the German case, despite very fast growth in the East. Second, a very substantial part of the servicing and subsidising costs have to be paid by other (non-German) economies in the union, without any obvious compensating benefits. Third, to reduce the need for continuing transfers actually requires a policy which promotes price and wage flexibility in the depressed region. That appears to run counter to the current market integration within Europe. © 1994.