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Vol 3, No 4
29 January 2001
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Cherries, Anyone?
Part four: experiences with privatisation and restructuring
Dr Bernhard Seliger

Read part one of this series
Read part two of this series
Read part three of this series

One of the main tasks in the transformation of the East German economy was privatisation. In the German Democratic Republic (GDR), in accordance with the to Socialist creed, there was virtually no private property or means of production. Between 1945 and 1949, the Soviet occupation forces in East Germany had already nationalised important parts of the industry and collectivised most of the land owned by the former aristocracy (the "Junkers").

Later, the GDR followed this path and, with the forced nationalisation of small enterprises in 1972, almost 100 per cent of productive capital was state owned. Firms were organised as state-owned enterprises (Volkseigener Betrieb, VEB) or as combines (Kombinate), large conglomerates that were characterised by vertical and horizontal integration.

Privatisation: an inevitable solution

In 1990, the consensus was that the form of property had to be changed. Economists of the property rights school had long before maintained that the form of property rights in state owned enterprises of Socialist countries was a major factor explaining the inefficiency of centrally planned economies. Thus, privatisation seemed to be inevitable.

But the way of privatisation was less clear: Western experiences with privatisation since the 1980s were limited to a few, maybe a hundred, public companies, which underwent a long restructuring period before they were sold on the advanced capital market. This was not possible in the case of the former GDR, where these preconditions were not given.

Another problem was the claim of former owners to forcedly nationalised property. The unified Germany wanted to allow justice to them by the possibility to restitute their property. The other alternative, namely compensation of former owners, was feared for its detrimental fiscal impact. But, in fact, restitution claims were a major obstacle in the privatisation of firms. Around 90 per cent of restitutions were contested, often resulting in a long-time blocking of any investment. Therefore, in 1991, the German parliament passed an "obstacle removal law," which gave priority to investment over restitution.

Removing the obstacles

On 1 March 1990, the last Socialist government of the GDR passed the first Treuhand Act (trusteeship law). With it, the Treuhand as a holding company of state owned enterprises was formed. Through this institution, the Socialists hoped to preserve such property as state property and also allowed members of the party and managerial class to strip the companies of their assets.

In July 1990, the first (and last) freely elected East German parliament changed the Treuhand Act. From then on, the Treuhand was responsible for the competitive restructuring and privatisation of its assets. In fact, the Treuhand became the largest company in the world: around 8000 firms, 120 of them combines, with at least 40,000 individual plants, were under the trusteeship of the Treuhand and were transformed into incorporated companies. The Treuhand resumed their credit payments and guaranteed their survival for some time. Additionally, around four million hectares of land, half of it farmland and half of it forest, had to be privatised by the Treuhand.

The so-called "small" privatisation of small retail businesses, movie theatres, restaurants and hotels, small craftsman and service businesses was comparatively easy. The Treuhand either allowed for a management buy-out (ie the management became owner, often leveraged by state-aided credit) or auctioned these firms away.

The highest bid is not always the best

However, the privatisation of the industrial property of the former GDR was much more complicated. Only a few of those companies that had a solid business basis (like gas stations) were cherries that were soon picked away. But most of the companies had a degraded capital stock, ancient technology, were highly overstaffed, had lost their markets in Eastern Europe due to the break-up of the Soviet-led economic system and were in a price-cost-squeeze due to monetary unification.

Therefore, the original expectation that the Treuhand could generate large revenue soon proved wrong. Also, the attempts by the state-led Treuhand to restructure thousands of companies and make them competitive before selling did not work. Instead of choosing the investor with the highest bid for a company, the Treuhand tried to sell companies to experienced investors with a track record, committing themselves to the highest guaranteed level of investment and employment.

In the five years of existence of the Treuhand, from 1990 to 1994, around 20,000 private firms came into existence, with around 210 billion Deutschmark of guaranteed investments and around 1.5 million guaranteed workplaces. With large state subsidies—which were sometimes judged to not conform with the EU competition law—industrial cores in steel production, shipyards and chemical industry could survive. Other firms that could not be sold were liquidated.

The balance

In retrospect, the sale to individual investors as opposed to the mass privatisation by vouchers in other Central and East European countries was successful. No other transformation country had completed privatisation before. Only experienced investors could guarantee the flow of capital and management know-how necessary for the survival of firms.

This process favoured West German firms, since their direct investment was not restricted by cultural, language or legal barriers typical for foreign direct investment. However, this was also a danger, since the oligopolistic structure of West Germany's industries (like in the banking sector) was transferred to the former GDR.

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Another problem was the subsidisation of capital costs. Rightly, the German government refused the subsidisation of labour costs, since this would have led to a distortion of the labour market, delaying structural adjustment. But the subsidisation of capital costs (in the form of special subsidies, government guarantees or tax breaks) was also problematic. While it facilitated the massive capital injection needed in the former GDR, at the same time it led to investment in high tech plants with few paid, highly-skilled workplaces.

The former GDR did not specialise according to its comparative advantage, namely an abundant, well-educated and cheap working force. So the balance of Germany's post-unification privatisation policy is mixed: there are some modern and competitive firms, but there is still a lack of sufficient employment possibilities in East Germany.

Policies, such as a larger wage-spread, to facilitate creation of jobs in the service sector are urgently needed. Unemployment remains the single most important problem in East Germany.

Dr Bernhard Seliger, 29 January 2001

The author works at the Graduate School of International Area Studies of Hankuk University of Foreign Studies and also does research at the University of Witten/Herdecke, Germany.

Read part one of this series
Read part two of this series
Read part three of this series

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