Underestimating East Germany

Conventional wisdom says the East German economy is lagging. But its cities may be poised to outpace the west.

At a glance, Frankfurt (Oder), a gray industrial city along Germany’s Oder River border with Poland, embodies everything that’s wrong with post-communist eastern Germany: decaying, empty buildings; skilled labor fleeing to the west; and unemployment rates well into the double digits—the precise opposite of its better known namesake in western Germany. Many visitors are just passing through on their way to Poland.

But looks can be deceiving. In recent years, behind the dingy buildings and unemployment lines, Frankfurt (Oder) has become a magnet for high-tech, high-skilled manufacturing and research. First Solar, a Phoenix-based photovoltaic-module maker, opened a 500-person plant there in 2007 to take advantage of Germany’s burgeoning clean-energy market and eastern Germany’s reputation for inexpensive, high-skilled labor. They haven’t been disappointed: originally designed to produce 100 megawatts of capacity a year, the plant and its workers are so efficient that, three years later, they are producing nearly twice that amount with the same equipment.

It’s a story repeated by foreign investors across the region. “Eastern Germany combines the best advantages of western Germany and Eastern Europe,” says David Wortmann, vice president for policy and communications at First Solar. “You have a very flexible and talented workforce, like in Eastern Europe, but on the other hand you have a superb infrastructure.”

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Monday marks the twentieth anniversary of the fall of the Berlin Wall, and Germany is taking stock of its track-record in bringing former East Germany up to parity with the west. By many accounts, it’s been a failure. Eastern Germans make only 71 percent of western German incomes, up merely four percent since 2000, leading many young, talented people to move west. Once-derided reunification skeptics like writer Günter Grass are now hailed as prescient forecasters. And record-high numbers of eastern Germans, known as "Ossis" in shorthand, say they feel alienated from their western countrymen and nostalgic for the economic security of the communist era. The New York Times, profiling the near-ghost town of Hoyerswerda, wrote, “In places like this former industrial mining town, the story of decline and departure has changed little in the former East Germany.” The result is dangerously high support for both left- and right-wing fringe parties, some of which hold seats in eastern state assemblies. For many, Eastern Germany is a lost cause.

But it’s not that simple. The east isn’t lagging so much as diversifying, with some areas nearly even with the west and others dropping far behind. Like the American Midwest, rural regions are hurting, but urban centers are bustling. In eastern Germany’s southern and western states, economic output is nearly at parity with parts of the west, thanks to massive federal spending in the 1990s and a wave of private investment, mainly in high-tech sectors, over the last decade. “You have extreme contrasts,” says Michael Burda, an American-born economist at Berlin’s Humboldt University. “Eastern Germany is in a medium-term position to overtake the West in some sectors”—including solar- and wind-power technology, health care, and nanotechnology.

According to Burda, instead of an east-west divide, Germany is reverting to its centuries-old norm: A north-south split, in which rural Baltic states like Schleswig-Holstein in the west and Mecklenburg-Vorpommern in the east lag behind southern economic powerhouses like Bayern and Sachsen. “It was easier for states like Sachsen and Thüringen to redevelop because they were traditionally industrial areas,” says Thomas Fabian, an economist with Germany Trade and Invest, a Berlin-based trade group. “Now we have well-developed places in the east and places in the west with problems.” In other words, the fears that eastern Germany would turn into a Teutonic version of Italy’s Mezzogiorno, condemned to weak growth and high unemployment, have been greatly exaggerated. Reunified Germany, long feared to be the “sick man of Europe” and a possible breeding ground for economic and social instability, is actually pretty normal.

German critics have spilled a lot of ink during the last 20 years attacking the government’s $2 trillion reconstruction effort in the east, calling it too ambitious, too dependent on the free market, and too ignorant of the social costs. In many ways they’re right: as in post-Soviet Russia, neo-liberalism, particularly rapid privatization, was the name of the game in eastern Germany in the 1990s—with the perverse result that western companies bought their new, potential competitors at closeout prices and immediately shut them down, causing massive unemployment. Meanwhile, though the region was being flooded with public funds, the realities of poor infrastructure and a dwindling work force deterred most private investors from taking the plunge. “In the beginning it was tough,” admits Fabian. “There were no real markets, either in eastern Germany or in Eastern Europe.”

Government investment in Eastern Germany in the 1990s was a lot like the fiber-optic bubble growing around the same time in the United States. Both focused on building out a robust infrastructure—in Germany, that meant roads, rail, telecom, and airports—in the hopes that customers would soon follow. When they didn’t, the bubbles burst. But while the short-term consequences were shuttered companies and chastened bureaucrats, the medium-term consequences have proven a boon to the next round of business development: just as America’s massive fiber-optic network has become the backbone of the Web 2.0 economy, so is eastern Germany’s robust infrastructure now a vital selling point for overseas investors. “You have the situation where the infrastructure in the east is more state-of-the-art than in the west,” says Fabian. Most recently, DHL switched its European hub from Brussels to the newly refurbished Leipzig-Halle Airport, in part because the eastern German facility offers 24-hour service.

Ironically, eastern Germany also benefits from the intellectual capital investments made during the communist era by the German Democratic Republic (GDR). Though today its collective steel mills are mostly rotting hulks, the GDR’s efforts to train scientists and workers in optics, biotech, and computer sciences left a legacy of highly skilled labor and robust research facilities—a key reason why the American chip-maker AMD opened an enormous factory outside Dresden in 2000, with countless others following suit. And while many of the best workers have migrated west looking for better jobs, the growth of relatively high-wage sectors in the east is drawing some of them back: according to First Solar’s Wortmann, ten percent of its Frankfurt (Oder) employees are former Ossis returning from the West.

It’s also important to keep east-west comparisons in perspective. In 1991,  the year of reunification, Eastern Germany was suffering from not just 45 years of communism, but  45 years of Soviet domination, beginning with a nearly complete looting of the country’s infrastructure after World War II. “We were essentially starting from zero” in 1990, says Fabian. East-West parity wasn’t going to happen overnight—or even over a few decades.

Moreover, the strategies pursued following reunification by eastern Germany’s local and state governments—eschewing conventional manufacturing, a crowded field, for relatively open sectors like renewable energy—meant sacrificing short-term booms for long-term growth. In other words, comparing east and west can be like comparing Detroit and San Jose circa 1965: It’s not a question of present performance but future potential. And indeed, large parts of the east are well-poised to skyrocket over the next decades. Half the country’s solar-energy jobs are in the east, which has just over 20 percent of its population, and 25 of its 27 manufacturers of next-generation, thin-film solar modules are based there. The five eastern states also boast 42 percent of the country’s wind-energy capacity, an unsurprising fact for anyone who has seen the phalanxes of windmills dotting the Thüringian countryside.

As a result, while the east grew relatively slowly during the 1990s, it has grown at higher annual rates than the west during the 2000s, with significantly better employment-per-project rates (186 jobs per new project, versus 79). And, thanks to their relatively small exposure to export markets (much of their production is for domestic consumption), the eastern states have been relatively unbruised by the economic crisis, shrinking an estimated 4.5 percent in 2009 versus 6 percent nationally.

The export question, however, is a double-edged sword—less exposure to foreign markets also means less benefit when those markets begin booming again. “When the crisis is over, eastern German companies are going to need to find a way to export,” warns Fabian. Eastern Germany has other persistent disadvantages: despite the swell in high-tech, high-paying jobs, out-migration continues apace, with one percent of its 18-29 year-olds leaving each year, according to Harald Uhlig, an economist at the University of Chicago who studies German reunification.

And then there are the subsidies that pay foreign and domestic companies to invest in the east, artificial supports that game the system for the new states. “If these subsidies were to be removed, what would happen?” says Uhlig. “My guess is, Berlin will remain a magnet for all kinds of reasons, Dresden may do okay, and I am less sure to pessimistic for the rest.” The subsidies are, in fact, coming to an end, shrinking annually with an expected closing date of 2019. Whether the eastern economy is ready remains an open question.

That said, eastern Germany’s skeptics and boosters alike see a similar future, one in which a few metropolitan areas—Berlin, Dresden, Frankfurt (Oder), Leipzig-Halle—reach parity with the West, while vast rural stretches continue to depopulate. That’s not the ideal envisioned by Chancellor Helmut Kohl and the Bonn government in the early 1990s, but maybe that’s not such a problem. “If people wish to move to West Germany, let them,” says Uhlig. “East Germany may become a nature paradise with a few vibrant cities, and I do not see why that would be a bad outcome.”