Closing the gap? The Financial Crisis and the German Länder (2024)

1The recent financial crisis began in April2007. It was caused by a two connected bubbles within the US, one of the housing market and one of the mortgage market. It swept over to Europe because cheap money had made it attractive to invest in asset backed sub-prime securities. The burst of the housing bubble and the following inability of many house owners to repay their mortgages brought banks owning sub-prime securities into severe problems. The end of one bubble caused the end of the other which led to a breakdown of several banks in September2008.

2In Europe the member states of the Eurozone with the exception of Greece, Ireland and Spain, were not immediately affected by the burst of the housing bubble. In Germany, prices of real estate have risen very modestly during the last twenty years, partly they dropped even; homemade problems with asset backed securities were hardly known.

3However, the financial crisis hit Europe and Germany because banks had invested into the mentioned sub-prime securities sold by American banks. The banks which had invested in them had to write off larger amounts of money bringing them at the brink of collapse. The federal government has to ‘rescue’ banks by taking them over.

4Looking at Germany and her neighbours Germany was the last nation hit by the crisis. While the growth rates of the neighbours slowed down already since fall 2007 Germany’s rates still accelerated in the first half of 2008. Since the second half of the year 2008 Germany’s growth rates dropped faster than those of the neighbours and marked – together with Italy and the United Kingdom – in the first and second quarter of 2009 the peak of the crisis. The ‘negative growth’ amounted close to 7percent while France and Spain fared better. From the deepest point of the crises Germany accelerated faster than the other nations out of the crisis. In sum, in Germany the crisis started later, was as deep, partly deeper, and ended earlier than in the neighbouring nations.

5Which effects did the financial and following economic crisis have for Germany? Consumption was not severely affected since consumers do neither heavily rely on credits (there will be no credit card bubble) nor on inflated house prices. The labour market remained comparatively stable, the unemployment rate rose by mere 0.3percent. German industry held skilled labour on a short hours’ base which was subsidized by the federal government by taking over parts of the social security payments. Altogether, Germany fared better than most of its neighbours through the crisis which is now declared to be over.

6Germany coped with the problems of the crisis primarily by deficit spending. In 2009 all levels of government together increased the public deficit by 116 billion Euros. The overall German public debt amounted to 73.2percent of the GNP (Statistisches Bundesamt, Fachserie 14, Reihe 5, 2009, p.117) which meant a rise of 6.9percent with respect to the year before (Statistisches Bundesamt, Press release No.095 of 11 March 2010).

7Money was not only provided for rescuing the endangered banks but also for the development of the public infrastructure, and for incentives for the industry to keep the work force in their jobs. Politically the situation was curious: On the one hand side the public debts reached new and unknown heights; on the other hand parliament adopted at the same time a constitutional ‘debt brake’ which is supposed to reduce deficit spending in the future.

8When we look at the sub-national level, to the Länder, we firstly have to take into account that the Länder do not have any substantial regulatory policy options of their own. Therefore the Länder were affected by the crisis but they were hardly actors in the crisis.

9Despite the Länder were more or less in a similar situation, the effects of the crisis were regionally different. Generally speaking the economically weak Länder, in particular in the East, fared better than the economically stronger Länder in West Germany. Expectations that the better off Länder would do better during the crisis became not true. Therefore, the crisis contributed to closing the gap between East and West Germany. Whether this development will prove to be sustainable remains to be seen during the next business cycle.

10Which effects did the crises have on the Länder, in particular on the East German Länder which are economically considerably weaker and more vulnerable that the other one? We will try to discuss this question by using four main indicators for their performance: the development of the GNP, the growth of jobs, the unemployment rates and the tax revenues earned.

11Taking into account the economic dynamic of the Länder since the year 2000 three groups can be distinguished:

12Firstly, despite the crisis four out of five East German Länder could raise their GNP by 2009 of more than 9percent above that of 2000: Thuringia (13.9), Saxony-Anhalt (13.1), Saxony (10.1), and Mecklenburg-Pomerania (9.4). The crisis hit them severely and threw them back economically on the status they had reached already in 2005. The second group counts those Länder which achieved an economic growth up to 7percent. They fell back on a status of 2004 or earlier. The ‘poor’ West German Bremen reached the top of this group featuring a growth of 7.2percent, followed by the last East German Land Brandenburg with 5.5percent. Two economically ‘strong’ and two ‘weak’ Länder have gained moderate growth rates: Bavaria 4.8, Saarland 3.3, Hessen 1.6, and Schleswig-Holstein 1.5percent. The least dynamic group – negative growth – could not stabilize the status they had reach already in the year 2000. This group starts with Northrhine-Westphalia (-0.2) and Baden-Württemberg (-0.8), followed by Lower-Saxony (-1.2), Hamburg (-2.3), and Rhineland-Palatinate (-3.4). Finally, Berlin’s economy shrunk every year since 2000 and encountered a ‘negative’ growth of -4.1percent with these 10 years. [1]

13The second indicator we look at is the number of employees. In Germany as a whole the number of employees grew between 2001 and the second quarter of 2010 by close to a million from 39.3 to 40.3 million. The West German Länder encounter during the period 2006 to 2008 a considerable growth of the workforce: 1.176 million new jobs within these three years. In 2009, the growth of the years before came to a halt. In the first quarter of 2008 the growth rate dropped to 0.5percent, in the second it came to a still stand, in the third and fourth quarter as well as in the first quarter of 2010 the number of jobs fell all together by 190.000. The recovery started in the third quarter of 2010. [2]

14In East Germany (without Berlin) the workforce was reduced from 5.8 million to 5.7 million persons between 2001 and the second quarter of 2010. During the period 2001 to 2005 the number fell by 200,000 from 5.8 to 5.6 million or 3.5percent. In the same time the West German workforce was reduced by 250.000 people from 31.9 to 31.7 million or by 0.8percent. The years 2006 and 2007 showed the same development in both parts of the country, a growth of 0.6 resp. 1.6percent. In 2008 the West German Länder experienced a faster growth of jobs (+1.5percent) than the East German Länder (0.8percent). In 2009 there was no change in the Western part while the East lost 0.5percent of its jobs. We can see, however, another change since the fourth quarter of 2009: in this period the East German development equaled the West German one. In the first two quarters of 2010 the number of employees in East Germany grew – first time at all – faster than that of West Germany. [3]

15Another indicator which also underpins the convergence of East- and West-Germany is the unemployment quota. The next graph shows that the gap of the unemployment rates between West and East Germany becomes smaller. The seasonal volatility is still larger in the East, but in particular in 2009 the West German rate remained stable while the East German one fell.

16When we look more in detail at the individual Länder the picture changes slightly.

17The gap between East and West is still visible, also the larger volatility of the labour market in East Germany which affects all Länder in the East. Most prominent in this respect is Mecklenburg-Pommerania. The labour market there is highly dependent on the tourist industry: more jobs in summer, less jobs in winter.

18Worth mentioning is that the city states of Berlin and Bremen are among the Länder with rather high unemployment rates: Both did not participate in the upswing of the labour market of the year 2009. The East German Länder were able to improve their unemployment rate while the West German rates remained more or less stable. The highest unemployment rate we find in Berlin: it reflects the low economic dynamic of the capital. The East German Länder suffer still from higher unemployment rates, however, Bremen ranks among them. The best ranking East German Land, Thuringia, has reached a position close to Northrhine Westphalia (9.2 vs. 9.0percent in October2010). The graph about Länder unemployment rates gives the impression of two rivers which are a point close before merging.

19The last indicator which we will take into account are the tax revenues of the Länder. We do not take the total tax income of a Land but omit all tax transfers including the (redistributive) value added tax. Included are the Länder shares of the income and corporation taxes as well as the taxes which accrue to the Länder only and are assigned to the Länder according to ‘local origin’.

20When we look at the per-capita tax income of ‘Landessteuern’ and locals part of the income and corporation taxes we see that the ‘wealthiest’ Land, the city state Hamburg (-13%), suffered the largest loss. Also Hessen, the main banking place in Germany, lost considerable tax income (-7%). Baden-Württemberg also lost, but just 3%. The only ‘loser’ from the ranks of the ‘weak’ Länder is Berlin (-10%).

21On the other side we see that East German Länder Brandenburg could raise its tax income by 33%, Mecklenburg-Pomerania by 24%, Thuringia by 23%, Saxony by 14%, and Saxony-Anhalt by 12%. The ‘weak’ West German Länder Lower Saxony achieved 8% and Rhineland-Palatinate 7% more. Remarkably Bavaria was the only ‘rich’ Land which increased its tax income: 10% more. The remaining Länder were stable, meaning between -1% and +2%.

22Generally speaking during the financial crisis the economically ‘weaker’ Länder enjoyed a more stable tax income than the ‘stronger’ Länder. Some of them were even able to increase their revenues.
The effect on the fiscal equalization scheme is – for the first time since forgotten times – a reduction of the transfer sums, and a reduction of the proportion of the Länder revenues which is earmarked for equalization.

23Apparently in the year 2010 we will see a continuous development. As expected, crisis and tax legislation reduced the tax income of all levels of government. The equalization payments fell to 3.618 billion€ in the first half of 2010 – compared to 3.769 billion€ in the first six months of 2009. The amount of money which has to be provided by the to be paid to the have-not Länder fell from 3.5percent to 3.0percent of the total of the Länder revenues. Remarkable, however, is not so much that the sum dropped, but the decreased proportion of equalization of the total of Länder revenues.

24None of the indicators will tell us a conclusive story of its own. For any particular indicator there might be special reason for a certain development: The different demographical developments have an effect on the unemployment. However, the improvement of the labour market in East Germany cannot be explained by the loss of population only because the number of jobs has increased. The growing tax income (and reduction of fiscal equalization) may be caused by a reduction of tax incentives, however the growth of the productivity per workplace/employee is also increasing. Taking all indicators together the whole picture supports the observation that the gap between East and West Germany which was growing for several years, in now going to get smaller. Remarkably, that happened during the financial crisis.

25It remains to be seen what will happens when the crisis has come to an end: The recovery in Germany follows the traditional German economic path. Growing exports are the driving force. A growing export rate would, however, favour the export oriented industries in particular in South and West Germany, not the East German industries. On the other hand, the newly developed industries in the East have established themselves in new markets and ‘niches’ like renewable energies. These industries might be stronger after the crisis because they are younger and more modern. It remains to be seen what becomes true.