Tuesday, 10 November 2009

When good politics was better than good economics

Yesterday was 9/11, written in the British way. It is as momentous a day as its American equivalent is tragic. For it was on this day, 20 years ago, that the Berlin wall collapsed. And Europe would never be the same again.

A trillion words are being written about the event and the celebration and the hoopla surrounding it. This blog is loath to add to that total, and in any case is not a political forum. Instead we will touch upon one of the most interesting aspects of the reunification at that time, the currency unification.

The word German reunification is actually a politically correct, but not factual, term – in reality it was an acquisition of East Germany by West Germany. When German reunification happened, the black market rate between the mighty Deutsche Mark and the Ostmark (East German Mark) was 1 to 5. The Ostmark would be abolished and instead the Deutshe Mark would be the currency of the new Germany. But then, at what rate do you convert the existing Ostmarks of East Germans ?

Economists fell over each other to proclaim that the exchange should happen at the fair value, which was the black market rate. They warned of huge inflation if it was converted at a rate better than the true rate. They also warned that if East German wages were reset in Deutsche Mark at anything other than the fair rate, East German industries, with their low productivity, would be outpriced, go out of business and result in high unemployment. Dire consequences were predicted by the economists.

The politicians however cared two hoots for the economists. Germany was in euphoria. It was one country, once again. The cold war was over. It was a momentous time. They grasped in a second that for the reunification to succeed, there must not be social upheaval in the East. They fixed the exchange rate as 1 Deutsche Mark to 1 Ostmark for upto 4000 marks and 1 to 2 thereafter.

Economists were outraged. Doomsday scenarios were predicted for Germany. East Germans were , as you would expect, mighty pleased. They embraced reunification wholeheartedly. West Germans were in fact giving a massive subsidy to East Germans. While there may have been some grumpiness at this, there wasn’t fierce resistance from them.

No doomsday scenario emerged. Inflation didn’t rocket up. Sure there was some pain and perhaps some prolonged impact on the German economy, but pick up it did. This was the best way to have handled the reunification – any other alternative might have been far worse. For once political logic triumphed over economic logic.

Look at Germany today. It is the engine of Europe, much as the British or the French might like to think otherwise. We go gaga over China, but even last year, the world’s largest exporter was Germany, not China. Despite all the chronicling of Germany’s economic woes, almost every country would give an arm and a leg to trade places with Germany.

But back to 1989. On that fateful day thousands of East Germans joyously crossed into the West. Amongst them was a 35 year old lady. Her name – Angela Merkel. Today she is the Chancellor of Germany. It probably wouldn’t have been possible, but for the fact that the politicians were right and the economists wrong.

23 comments:

A journey called Life said...

lovely read.. and extremely informative

Sabareesan said...

Ramesh this is truly an amazing eye opener.

athivas said...

Thanks for sharing this and enlightening us.

Ramesh said...

@AJCL : Thanks

@Sabareesan : Hey thanks for a kind comment

@athivas - Mikka nandri :)

Deepa said...

Like I've said before, 'BM' is one lecture I hate to miss! Very informative!

Sandhya Sriram said...

@ cost of repeating an earlier comment - indeed a real eye opener.

Political will can make a big difference. I feel, India got out of Satyam far better that enron coz very quick and right steps were taken, right people were put on the board with enough empowerement and quick decisions were taken. (ofcourse i consciously overlook the fuss on arresting ppl and all which you had written about earlier)

There are some good examples and loads and loads of bad examples. The very angela merkel and her unwarranted intervention in the GM episode is a neat example of the latter.

Durga said...

Very informative post. Thanks!

Exkalibur666 said...

Great post, thanks for the information.. thoroughly enjoyed reading it.. just speculating what would happen if N & S Korea do the same sometime into the distant future..?

Adesh Sidhu said...

And I read somewhere that it was by mistake they gave orders to cross the boundaries. There was no official message regarding this and journalist asked one politician 'when people can cross'. Not knowing exact time he said, 'This is the right time' and it was live broadcast. People listened and everybody rushed...
BTW Sarkozy (French President) was also present while this historic thing was happening!!!

J said...

The intermingling of economic and political pressures on history is fascinating - sometime economics drives the politics and sometimes it is politics despite the economics. Such an extraordinary human success story, all in our lifetime. Very well written.

hansjoerg said...

Ramesh,

as always I am very impressed about your insights and your balanced comments. I like to thank you for commenting on the German reunification process at the night of the twenties anniversary of the fall of the Berlin Wall.
At that times I was personally in the in the eye of that tornado as I was living and doing business in Berlin. I remember the spring of 1990 I was selling high tech computer equipment to East German companies against Ostmark at a rate of 5 to 7 Ostmark for the value of 1 Westmark. Everyone honestly believed this will be eventually the value of converting the Ostmark. When than in summer 1990 the conversion happened to the big surprise of everyone at a rate of 1 to 2 one fall out was that most of these companies did not survived for very long anymore to benefit from that new high tech gear. With the introduction of the Deutschmark (Westmark) most of these old companies lost their markets at home and in the Eastern block countries and with that millions of people lost their jobs and with it the promised vibrant and glorious future which they had hoped for. The East-German economy at zero time to adapt to the news conditions.
You are absolutely right, the boldness , and the speed of action of some of the politicians in power at the time should be recognized and thanked for, specifically as we always tend to blame our political leader for all and everything what goes wrong. It was Helmut Kohl (an historian by education) who saw that(probably)very short window and decided to move very fast. He had the full support from Gorge Bush (the father not the son) and he build a trustful relationship with Michael Gorbatshov and got the French president Mitterand and eventually Margret Thatcher the English prime minister at the time to accept process of reunification. Kohl focused on the politics and did not spend time to listen to economical advisor’s . In retrospect the right thing to do and in another twenty years when the debt of the 1 to 2 conversion is paid off and the industry in East Germany is rebuild all the economical fall out will be history.

Durga said...

Hj, your post was more of "insider information"! Very good insight.

Srivats said...

//athivas - Mikka nandri :)//

adengappa, padikkavey sandhosama erukkey.

Ramesh this is such a informative post for all of us. I appreciate your efforts of bringing economy news to everyone in very simple form.

The title the content and the ending all top class! very professional writing and definitely a content worth publishing.

Hope to see ur name in magazine or paper someday :)

mahesh said...

Thanks for the informative post Ramesh.

Wonder if Barack Obama is a fan of your post... and if he is probably we might see some better decisions in the US by him not listening to his advisors...

Ramesh said...

@Deepa - Thanks . I am much flattered

@Sandhya - In the Satyam case, I think credit goes to Karnik & Co and egg on the face to the government !

@Durga - Thanks. I was waiting for Hansjoerg's comment - he is of course the authority on this topic.

@Exkalibur - Yes N&S Korea, but maybe, just maybe, one day, India and Pakistan ....

@Adesh - Yes, it was by a premature announcement during a press conference, that it all broke. Sarkozy is claiming to have been there, but there are some doubts. A French newspaper, tired of Sarkozy's claiming credit for everything has asked him if he was also there for Napoleon's coronation !!

@J - Isn't it. Over history, politics and economics has always been inseparable.

Ramesh said...

@Hansjoerg - Thanks very much for your expert comment. It must have been momentous times - living in Berlin when it all happened and seeing it all first hand. Yes Helmut Kohl acted decisively and deserves much plaudits, but I wonder whether history is kind enough to him or has forgotten him.

Ramesh said...

@Sri - Oh; you make every day of mine with your wonderful comments. Thanks so much.

@Mahesh - Now you are giving me ideas ... :-) , :-)

kiwibloke said...

Very nice article - pretty heart warming to know that some politicians did exist who took bold decisions.Herr Kohl is an example. Reminds me of another president, a statesman and a nation builder of the post war US. (was it Harry Truman?). His famous quote while rebuilding post war America was "Give me a one-handed economist! All my economists say 'on one hand...on the other".

thethoughtfultrain said...

Trust you to come up with a fresh view of what is being written about everywhere! :-)The title to this post is just as incredible as the post itself. :-)

Half Indian said...

Politically and economically, you are very far-sighted.

Ramesh said...

@kiwi - Yes, it was Truman indeed.

@thoughtful train - Gee ; thanks

@Dave - Oh thanks so much.

Ravi Rajagopalan said...

As it turns out, the opening of the wall was no lucky accident. The Mayor of West Berlin had been told to expect it, and when the wall was breached he instructed the head of the U-Bahn to ensure that traffic flowed freely and control measures were in place. It does not in any way retract from the romance of it all. Though Mitterand and Thatcher opposed the re-unification of Germany, the East German state was going to implode any day, and Kohl ignored his allies and did what was right for Germany.

The division of Germany was not ideological, it was a result of military movements in 1945. There was always an outside chance that it could end, and it did. But in the case of India and Pakistan, I am afraid I would not support re-unification. India needs a buffer state to protect us from Central Asia. It is in India's self-interest to preserve Pakistan as an independent state. No happy ending there.

Ramesh said...

@Dada - Yes, Kohl did the right thing and did it well. India and Pakistan ? - well; I understand what you say, but there's something wildly evocative about the idea. Perhaps not in our lifetimes, but then who knows ...

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