Editors' Summary

The brookings panel on Economic Activity held its seventy-second conference in Washington, D.C., on September 6 and 7, 2001. This issue of Brookings Papers on Economic Activity includes the papers and discussions presented at the conference. The first paper revisits the economy of the former East Germany ten years after reunification, seeking to explain why its convergence toward western German economic performance has stalled. The second paper reviews macroeconomic policymaking in Japan to determine whether the stagnant Japanese economy has responded to policy stimulus as conventional models would predict. The third paper tests alternative explanations of the greater generosity of social welfare systems in Europe than in the United States. And the concluding paper attempts to reconcile the observed high return on equities with reasonable levels of risk aversion on the part of individuals.

The reunification of Germany, which began with a bloodless revolution in 1989, was one of the most dramatic economic and political events of the twentieth century. The process of integration that began officially in 1990 with economic, social, and monetary union provides a vivid case study in the difficulties, even under highly favorable conditions, in achieving the convergence of living standards in two regions at very different levels of development. The less developed former East Germany faced no language barrier; it could easily import the political, legal, and economic system of the west; its people could migrate freely; and it received massive inflows of capital. In the first paper of this issue, Michael Burda and Jennifer Hunt examine in detail the economic performance of eastern and western Germany during the first decade after reunification, analyzing changes in output, employment, investment, consumption, and wages to better understand the productivity gains of the east.

The authors' overview of economic developments since reunification identifies a number of surprises, both good and bad. After an initial drastic decline, eastern Germany's GDP per capita grew rapidly from 1992 to 1995, reaching two-thirds of western levels. Labor productivity, consumption per capita, and wages did even better, rising to more than 70 percent of western levels by mid-decade. The authors illustrate the convergence in consumption by comparing rates of household ownership of selected consumer durables. In 1991 few eastern Germans owned dishwashers, microwave ovens, video cameras, refrigerator-freezers, or even telephones. But by 1998, 44 percent of eastern German households had dishwashers, 54 percent had microwaves, 38 percent had video cameras, 35 percent had refrigerator-freezers, and 97 percent had telephones. By that year the prevalence of ownership of automobiles, telephones, color television sets, refrigerators, refrigerator-freezers, stereos, video cameras, and washing machines was essentially the same for eastern and western Germans.

This convergence is impressive and happened much faster than previous studies of regional convergence would have predicted. Viewed from the end of the decade, however, prospects for complete convergence do not seem as bright. Since 1995, consumption and GDP per capita, wages, and labor productivity have all been stuck at essentially the same fraction of their western counterparts. And whereas output and consumption have more than regained the ground lost following the initial shock of the transition, the labor market has yet to recover. Various measures give different indications of the extent of unemployment: survey measures suggest that unemployment averaged 13 percent from 1994 to 1999; official estimates are higher, with unemployment approaching 20 percent in 1998, or 27 percent if estimates of hidden unemployment are included. The share of the eastern working-age population that is employed declined from 83 percent in 1990 to 65 percent in 1999.

To help explain the early successes and the more disappointing performance that followed, the authors undertake a careful analysis of eastern Germany's output growth, grounding it in a conventional growth accounting framework. They believe much of the large gap in labor productivity between east and west in 1990 reflected the relatively low capital-labor ratio in the east. Given political stability and firmly established rules for a pan-German market economy, this difference in the capital-labor ratio provided a powerful incentive both for labor migration to the west and for capital accumulation in...