Agriculture in eastern Germany is undergoing enormous chan­ges due to the introduction of market forces and the unification of Germany. The shift of that economy from communism to a market economy has profound direct impacts on U.S. agriculture and provides lessons for other eastern European nations.

This article discusses the eastern German experience during the first two years of economic reform and presents some longer-run influences on U.S. agriculture. To do this, the interaction of agriculture with the total economy is considered. The article begins with a description of the development bot­tlenecks facing eastern Germany, then covers the policies used to release these bottlenecks. The third section summarizes the initial reaction of the economy to market forces. The final section speculates on how the United States will be affected.

 

Development Bottlenecks

 

The problems facing eastern Ger­man economic development with the fall of communism can be grouped into four categories. These are related to one another. The economy needs vast amounts of capital investment as well as a reallocation of labor. These changes can only be accomplished if a completely new system of economic, political, social, and legal rights can be created and preserved. Without these conditions, eastern German firms and farms are unable to withstand competition from western nations.

Driving into eastern Germany, the need for investment is clear. The capital stock is old, worn-out, and the technology outdated. Essentially all houses, buildings, roads, railroads, and other capital must be replaced. The agricultural situation is equally poor. More than one-half of the animals are housed in outdated facilities. These facilities contribute to high production costs as they are labor-intensive and in poor repair. The existing size of units is a serious problem -under central planning, investment was directed into excessively large buildings which can­not be subdivided into the smaller units needed by private farmers. A similar situation exists for machinery as the average age for tractors is 14 years and that for other equipment is 15 years. Estimates of the cost of modernizing the capital stock range from 750 billion dol­lars and up.

The labor market is a particularly serious development constraint. In the communist period, labor was not paid based on its performance and could not be dismissed. The result was that labor was overpaid and undermotivated with adverse effects on productivity. Estimates of labor productivity with respect to West Germany varied from 30%-50%. Firms and farms organized along industrial lines carried more labor than needed and this labor became specialized. A worker who drove a farm truck could not be used in field opera­tions or in livestock facilities. There are no farmers in the western sense and many individuals are reluctant to become private farmers as they lack the knowledge and the willingness to accept risk.

 

With the opening of the border, eastern Germany faced two problems. First, labor had to be released from over­staffed enterprises in all sectors at the same time. Second, the labor that volun­tarily left for the west was generally the younger skilled labor needed to effi­ciently operate firms. Loss of this labor threatened to damage the economy by creating an unfavorable age structure. Young skilled labor needed to be retained while at the same time sharply reducing the total employment.

A major problem is rebuilding the system of economic rights. This is a complex and difficult task as an entire catalogue of conditions had to be intro­duced, including private ownership, employment freedom, a functional banking and tax system, investment freedom, and contract freedom. Also, a market economy could not be success­fully introduced without an under­standing of how such a system functions and what rights and obligations exist. These functions form the essential structure of a market economy. Without these preconditions, other reforms such as price reform, currency reform, and investment aids have limited effectiveness.

These bottlenecks create a competi­tiveness problem for eastern Germany, as hardly any firm is competitive in international markets and the capability to become so is limited. Analyses of collective farms made before unifica­tion predicted negative returns. Intro­duction of prices as set by the European Community (EC) reduced agricultural income 48%. Without major adjust­ments in production patterns, inputs, and farm organization, there is little chance for farms to survive.

 

Breaking Obstacles to Development

 

This section describes the com­prehensive set of policies used to attack the problems facing eastern Germany following the end of the communist government. The cost to Germany of these measures in 1991 was over 100 billion dollars and spending at that level will likely continue for the next several years.

Rebuilding the economic, social, and political system is being accomplished in the form of four instru­ments. The first tool is the treaty of economic and monetary union of July 1, 1990. This treaty replaces the existing East German economic system with that of West Germany. The West German mark has replaced the East German mark at an overvalued rate. The EC’s agricultural policy has been transferred with temporary special provisions. This treaty also transfers other features of the West German economy, such as labor law and social insurance policies.

 

A second treaty of October 3, 1990 transfers the political system of West Germany to the east and created a unified country – at least officially. These treaties create the necessary preconditions for functioning markets.

An important aspect of the shift from communism to a market economy concerns private property. Privatization of state-owned assets is the responsibility of an agency established for that task – the Treuhandanstalt (Treuhand). State-owned assets have been transferred for administration to the Treuhand which is to sell them for profit when a return to previous owners is not possible. Also, the agency is expected to aid the struc­tural adjustment of the economy and to rationalize businesses. These objectives are contradictory and the actions of the agency create much controversy. Since there is an excess of labor, the Treuhand has sharply cut employment and labor groups often see it as hostile to job creation. For farmland under its control the Treuhand operates with leasing agreements. Actual sale is to be spread across decades to avoid disrupting the land market.

Much of the agricultural land and capital officially remained the property of collective farm members without the right to determine its use. This land is shifted from collective farms to private farms through the agricultural adjustment law. The law grants all voluntarily formed business organizations equal competitive opportunities and estab­lishes procedures for transferring collective farms’ assets to other forms. A critical feature of the law is that the value of the collective’s assets and the debt structure must be established and divided among hundreds of members. Foregone labor and capital payments must be paid from the collective’s value. A series of disputes are arising over valuation, division, responsibility for debts, the claims of departing members, EC quota rights, and procedures for dissolution.

The uncompetitive firms and farms in eastern Germany require new capital investment. Labor must be retrained for other jobs. Those are long-run processes, and in the short run, much of the economy cannot compete with western firms. This means liquidity problems for businesses and unemployment. A series of short-run transfer programs are used to give firms and farms liquidity as well as aiding displaced workers. The intention of these programs is to keep as much economic activity underway as possible and to smooth the labor adjustment. There is an extensive number of reeducation and retraining programs. Several forms of early retirement schemes have been introduced. Through the end of 1991, firms were paid to keep unneeded labor on the payroll.

There are a large number of programs offered to eastern Germany with the intention of restructuring and modernizing the economy. These investment aid programs are targeted by activity. Most are indirect subsidies in the form of reduced interest, credit assistance, credit guarantees, accel­erated depreciation, and tax credits. They are large in number and in spend­ing, with the expectation that outlays will be required for years to come.

 

Actual Adjustments Seen

 

The patterns of adjustments to a market economy are along the lines expected, but the severity is greater. Unemployment (including short-time labor) rose quickly during the summer of 1990 to over 20 percent. By early 1991, effective unemployment was around 30% and has stabilized at that level since. Of the 850,000 employed in agriculture in 1989, about 250,000 remain. Before the border opened, wages in East Germany were about one­third those in West Germany. With the changes there has been tremendous upward wage pressure, and wages now are about 75% of western levels. The goal of labor unions is wage equalization by the mid-1990s. Wage increases have outstripped productivity increases, thereby raising labor costs for firms with adverse effects on output and employment.

Economic reform in other countries has often been associated with inflation, but this is not a serious problem in eastern Germany. One reason is the monetary overhang and pent-up demand was not as serious as in other nations and was quickly satisfied by imports from western Germany. The German central bank is committed to fighting inflation. The economic and monetary union puts downward pressure on output prices. The average producer price for industrial goods halved from May to July 1990. The pricing structure of the communist government was not one of exclusively low prices. Prices for durable items were kept high so that liberalization allows these prices to fall. The system of consumer subsidies is being removed gradually so that the price adjustment is smoothed. While consumer prices for food are roughly 25% higher without the subsidies, farm prices collapsed with the introduction of EC prices. The East German government followed a food self-sufficiency policy and prices for producers were excessively high even compared to prices in EC countries.

The output of the eastern German economy has fallen sharply and has shifted its composition. Industrial output is the most serious problem -down 32% in 1990 and another 60% in 1991. The construction, distribution, and craft sectors contracted in 1990, but have been expanding since then. The service sector of the eastern Germany economy has become the winner with an increase of 23% in 1990 and 40% in 1991. It is now the largest sector, whereas before it was about one-third the size of industrial output.

Agricultural output was also adversely affected. In 1990 its value fell 37% and in 1991 another 13%. The downward adjustment in livestock generally exceeded that for crops. In 1990 the cattle herd fell 14% while swine and layers were down 27 and 28%. In 1991 the drop in cattle slowed to 4% (milk cows continued to drop at 17%). Populations of swine and layers continued to drop sharply – 26 and 16%. Crop area adjusted little the first year, with the 19% decline in potato area the exception. Area in 1991 had time to adjust and with the introduction of the EC set-aside more changes occurred. Grain area fell 19%, sugar beet area 23%, potato area 68%. Within the grain area there was a shift away from rye and oats and in favor of wheat and barley. Rapeseed was the winner with a 112% area expansion due to the less severe producer price decline.

For the 1989-1991 period, some patterns are clear. Livestock inventories fell earlier than did crops and the adjustment was greater. This type of adjust­ment under EC conditions was expected. The relative shift to EC prices was to the disadvantage of livestock. The old, labor-intensive capital stock was in poorer shape in the livestock sector. Crops could more easily adjust input use and the large crop farms could more easily be divided among individuals. The EC milk quotas and limits in the investment aids programs on livestock investment disadvantaged livestock. Sale of livestock and crop set-aside were attractive to farms in desperate need of liquidity. Finally, the food processing sector of eastern Germany was no longer functional and crops could be more easily sent west for marketing.

 

Influences on the United States

 

The developments in eastern Ger­many will influence U.S. agriculture. There is the issue of whether eastern Germany will be a market or a com­petitor. Also, the influence of eastern Germany on EC decision making and policy must be considered. Finally, there are lessons for our development assistance to eastern Europe.

When the Berlin Wall first collapsed, many recalled that East Germany had been a major market for U.S. grains and soybean products in the 1970s. With the economic problems in East Germany, that market had stagnated and shrunk. Could it be that economic reform would expand market opportunities for U.S. farm goods? Given the shifts of the past few years, the answer appears at this point to be no. There is no evidence of an expansion in food demand, as eastern Germans have always had volume; rather, there is a shift to western German consumption patterns. That means more quality and variety, but not quantity. Consumption of grain products will fall with greater expenditure on fruits and vegetables. Feed demand will be lower as the role of livestock is reduced. The shift in farm production patterns shows increased output of grains and oilseeds. Eastern Germany will be a surplus producer of these commodities and will export them either to the world market or EC storage. There may be market oppor­tunities for specialty goods, including corn gluten.

The influence of eastern Germany on German and EC policy is in its infancy and difficult to predict. The development needs and farm structure of the east create a fundamentally dif­ferent farm policy agenda for German policy-makers. They must deal with a farm structure of tiny farms in the west and farms of thousands of acres in the east. This has put tension into farm policy in Germany and the EC. Whereas initially Germany favored targeting programs to small farmers, that position is gone. The Germans are trying to gain advantages for the east as a special region. The cost of reform in the east also affects the situation. Western German taxpayers are making large transfer payments to the east. The Germans have also been the major contributor to the EC budget. With German unification the German budget situation has become serious. They cannot continue as the paymaster of Europe and actually need an inflow of foreign capital and EC development funds. In the recent EC agricultural policy reform discussion, the Germans departed from their normal policy of opposing price cuts and accepted reform. Yet they fear the effect of reduced prices on the weak eastern farms. This attitude also affects their view of the GA TI negotiations. German domestic farm policy and their views on EC policy are presently divided and erratic.

There are several lessons from the German experience. Adopting the mechanics of a market economy without the necessary functioning institutions will have limited effectiveness. Another lesson is the critical role of the labor market to the reform process. Labor market failures in east­ern Germany have undermined the development process. The complicated task of restoring private property must be done carefully and quickly. The German court system is overcome by property claims and physical restitution will take decades. This derails the needed investment. The German experience also shows the problems of using investment aids when businesses face liquidity problems and no collateral. Schemes to aid investment when citizens cannot offer collateral and have persistent liquidity problems slows the development process.