What can and what can’t the state do?

An answer to this rather broad question is one of the issues that formed the subject of Alexander Fink´s presentation during the discussion forum on the topic of “East German Transformation and German Public Finance” organised by Liberalni Institut on Wednesday, March 14, 2012.  Before we are able to even tackle this question, it is necessary to put it in to proper context.

The first issue that Mr. Fink discussed was the method of evaluation regarding the success or failure of the East German transformation. He pointed out that in the early 90s, politicians were promoting the idea of “blossoming landscapes” (blühende Landschaften)^[1] and in this context people were generally expecting that East Germany would look like West Germany in a couple of years. However, in retrospect this could be viewed in some regards as a failure. It is fair to ask – were these expectations correct? Should East Germany only have been compared with its Western counterpart or should it rather be evaluated in the context of other Central and Eastern European countries that also went through the process of transformation? In this regard, Mr. Fink followed Shleifer and Treisman (2005)^[2] who argued that the performance of Russia should not be regarded as the poor performance of a highly developed country, but rather a performance of the typical middle-income capitalist democracy. In this context, Fink tries to evaluate the East German transformation in comparison with not only West Germany, but with a group of Eastern and Central European countries as well.

picture: tatraskoda

Alexander Fink further argued that the German unification presented an opportunity to assess the successes and failures of the state^[3] and an opportunity to look at what the state is and is not able to do. In order to accomplish this goal, he evaluated the evolvement of several indicators that were able to a degree to demonstrate the effects of government activities.

Firstly, Mr. Fink presented a comparison of the number of phone lines per inhabitant. He showed that in 1993 East Germany was in a similar situation as the group of Eastern and Central European countries and that there was gap between them and West Germany (a gap, that according to the data from 2008, still persists, but on a smaller scale). However, even just after 8 years, East Germany was able to leave the group and caught up with West Germany. In this particular example, the original view of “blossoming landscapes” might not have been that far off. Furthermore, it can be taken as an example that in some cases, the state is able to achieve some specified targets.

The second example Mr. Fink provided, was a progress of the unemployment rates. He showed that while East Germany was not worse off than the group of Central and Eastern European countries, it was not able to outperform them and catch up with West Germany.

In what regard are the two indicators different? Why was the construction of phone lines successful, while the reduction of unemployment ended up being a relative failure? According to Mr. Fink, the phone lines had some important properties differing from unemployment. It provided a relatively narrow target and could be tackled directly. He argued that it would be possible to identify some agency in the government structure that was directly responsible for the phone lines. That it is traceable. He further argued that this differs from the case of unemployment and even though its reduction is a stated intent of many politicians, it does not present them with any real target. There are no tools available to directly increase or decrease unemployment. It is a rather broad measure that cannot be tackled directly. Of course, that is true unless the state would decide to take the extreme action and simply hire everyone or hand out subsidies in order to hire people. It could thus be argued that no government agency can be held directly responsible for the reduction of unemployment in the given area, since in order to make some agency responsible, it would also have to be provided with the proper tools.

Furthermore, Mr. Fink examined the development of another indicator, the number of cell phones per 100 inhabitants, and showed that there does not seem to be a significant difference in the progress of West and East Germany. He argued that this might be caused by decentralization of the implementation process and that in this case, having the assistance of West Germany might not have had a significant influence.

To sum up, in order for the state policy to be successful, the target has to be relatively clear. It is more difficult to produce results with broad targets such as the increase of income or the reduction of unemployment. Thus, even though there are cases where having the support of West Germany might be beneficial, it is only true for a relatively restricted number of issues. Furthermore, the particular positive effects could be largely attributed to the significant transfers from West Germany to East Germany. Mr. Fink provided an estimation of these transfers at approximately EUR 80 billion per year (those are only rough estimates, since it is almost impossible to quantify these numbers exactly). However, he further argues that East Germany was unable to close the absolute gap with West Germany (in terms of GDP) and argues that in that regard there does not seem to be an absolute convergence between East Germany and West Germany. Thus, even though the transfers might have improved the East German performance with respect to the narrow targets that could have been assigned to the government agencies, they did not significantly improve the performance with respect to the decentralized indicators (income, unemployment, the existence of mid-size companies). Moreover, even though some positive benefits of these transfers are apparent, there are also a number of negative impacts that are not visible.

In the end Mr. Fink concludes that even with the existence of a highly developed country that is willing to help out its less developed neighbour, the state cannot actively create prosperity. That is up to the people because the state can only provide circumstances in which people can tap into their own potential.