Costs of German Reunification Slow Europe's Economic Engine

THE cost of German reunification, far higher than first imagined, has Europe's economic giant trembling.

In order to revive east Germany, the public sector is stacking up record debts. Just for this year, the public debt will top 100 billion deutsche marks ($61 billion), economists estimate.

But most of this massive borrowing is not being used to actually rebuild the collapsed economy in the east. Of total public spending on east Germany, only about 25 percent is for investment in highways, the telephone network, and other infrastructure. The rest is flowing directly into the pockets of east Germans as unemployment benefits, pensions, and social services.

This is a political necessity, economists say, because it raises the east German standard of living just enough to prevent another mass exodus westward. But other than stimulating consumerism, it does nothing to improve the economy permanently.

The engine that has been pulling east Germany along - the west German economy - is at a near standstill. Last week the country's five leading economic institutes revised their 1992 growth forecasts for west Germany sharply downward to 1 percent from 3.1 percent last year.

The institutes also predict inflation in western Germany will hit 5 percent this year, not bad by world standards but a horror to fiscally conservative Germans. Western German trade unions are sending tremors through industry with double-digit demands for wage increases.

Politicians and economists criticize the demands, saying they feed inflation and undermine the one-year 7.5 percent reunification tax placed on Germans last year. What's needed in Germany today is austerity, they argue, not largess.

The German public is acutely aware that the economy is amiss. Voters jolted the established parties this month when many swung behind right-wing extremists in regional elections.

A major reason for the protest vote was Germany's refugee problem, but political analysts also read it as a sign of anger at the rising cost of reunification.

Politicians as well as economists grossly underestimated the cost of reunification, says Peter Pietsch, an economist with Commerzbank. In 1990, the generally accepted estimate was that it would cost Germany 100 billion marks a year ($61 billion) to rebuild the east. Over the course of 10 years, says Mr. Pietsch, it will likely turn out to be twice that much.

Simply put, the economy of the German Democratic Republic was much more decrepit than anyone in the west had imagined.

"I knew the GDR well; I was there 20 or 30 times before the [revolution]," said Birgit Breuel, head of the Treuhandanstalt, the agency charged with privatizing the east German economy.

"I knew it was worse than the statistics showed, but I had no idea just how catastrophic it was. It was a major shock," she said.

East Germany's claims that its was the world's 10th largest economy were "officially planted mistakes," concluded Ms. Breuel in a recent discussion with foreign journalists.

A common criticism of Chancellor Helmut Kohl is that he missed the opportunity to ask for belt-tightening to help pay for unification.

In the emotional run-up to unity and the national elections in 1990, when many west Germans appeared ready to share the wealth with their poorer neighbors, Mr. Kohl kept insisting that new taxes would not be necessary to pay for unification. When he broke this promise last year and installed a special one-year "solidarity" tax, the public turned sour. Some Germans ask why Kohl does not cut back his own salary as a symbol of his readiness to sacrifice.

Germany is having great difficulty practicing financial self-discipline. The five economic institutes estimated public sector debt of the federal government, states, and communities this year at 100 billion marks ($61 billion). This includes special funds to help finance unification.

But the grand total, including the losses of the Treuhandanstalt as well as such publicly owned, money-losing enterprises as the rail, post, and telecommunications networks, will be much higher, around 180 billion marks ($110 billion), says Pietsch.

The debt problem, he says, "is clearly one of the major risks in the German economy." Mounting debt is a factor in Germany's historically high interest rates, which in turn increases the burden on Europe's recession-bound countries.

With the financial need so great, this would have been a perfect time for Germany finally to trim or eliminate expensive subsidies to such sectors as mining and agriculture. So far, there has been tough talk but little action, mostly because of the political clout miners and farmers wield.

Economists have given up hope that subsidies will be seriously cut, says Heiner Flassbeck, an economist at the German Institute for Economic Research in Berlin. "We're now realistic. Even in the boom of the last few years, it has not been [politically] possible to cut subsidies."

Because the economic institutes no longer consider subsidy cuts a realistic option, says Mr. Flassbeck, they now recommend that federal and state governments cap spending growth at 4 percent a year through 1996, effectively freezing the budget below the rate of inflation.

Finance Minister Theo Waigel promises to do better by keeping the federal budget at a growth rate of less than 3 percent a year through 1995. He has called on the states to do the same.

The finance minister has a few things working in his favor. He can look forward to the increase in the value-added-tax, which will kick in at the start of next year. And it is nearly certain that Germans will shoulder more of the nation's health and pension costs through higher contributions.

The military budget, too, is glaringly ripe for cutting in the post-cold-war era. And if the government hangs tough, and can weather threatened strikes from public workers, it might be able to hold wage increases to less than 5 percent. The original demand was 9.5 percent.

Though troubling, Germany's debt problem is not as bad as that of the United States or Japan, says Paul Horne, international economist for Smith-Barney in Paris. He pegs the country's total outstanding debt for this year at 45.6 percent of gross national product, in comparison to 59 percent for the US and 61 percent for Japan.

The Germans are known worriers, he says, "they have to be protected from themselves."