No Special Sauce on This Currywurst

Imagine, for a moment, what might have happened if the North American Free Trade Agreement had been something a little different, something a little more … intense. Imagine that Mexico had not just opened its borders to American goods and services but had actually become the 51st state. Furthermore, imagine that all Mexicans had learned to speak English overnight. Extreme poverty in Mexico had disappeared, and much of its workforce had instantly acquired manufacturing skills. Finally, imagine that Mexico had, for the previous several decades, assiduously cultivated trading relationships with the rest of Latin America. And now, imagine that some years after this miraculous unification of Mexico and the United States, the U.S. dollar had become the common currency of much of the hemisphere. Can you see where I’m going with this?

When East and West Germany reunified in 1990, the whole was much greater than the sum of its parts. The East got the West’s airtight economic institutions, its culture of precision in manufacturing, and its central position in the global economy. The West got a huge inflow of new workers — the equivalent of about a quarter of its existing labor force — and access to an enormous market that had been shut off since World War II. This market wasn’t the wealthiest, but it had plenty of room to grow. And though these new workers weren’t quite as productive as their counterparts in the West, on average they were more than 50 percent cheaper.

The sudden addition of millions of lower-wage, lower-productivity workers to the German labor force dramatically raised the return to capital. Once the initial growing pains of reunification subsided, investment started flowing in. Giving the new workers better equipment and installing them in refitted factories immediately made them more productive. At the same time, their lower wages made German exports much more competitive.

Then came the euro. Germany’s exports to the eurozone became easier and more transparent, and buyers outside of the monetary union could pay for German goods and services with a versatile new currency instead of the trusty but limited deutschmark.

So, was it any wonder that Germany became a world-beating exporter? The first couple of years after reunification were rocky, and exports actually dropped. Then came the miracle: Germany’s exports grew faster than its gross domestic product in every year from 1994 to 2008, when the global financial crisis started. In those 15 years, exports tripled while GDP (adjusted for changes in prices) expanded by just 27 percent.

Until the onset of the euro crisis, these stunning results had plenty of people saying that Germany had discovered some magic formula for export-led growth in an advanced economy. In The American Prospect, Eamonn Fingleton wrote, "It is high time the German economy got some respect" and called the German model "an extraordinary engine of economic success." It’s true that Germany made some slight changes in economic policy during those boom years, including reforms in the labor market and the pension system. But pointing to those changes as the source of its growth was to ignore the elephant in the room — the elephant with the word "reunification" painted on its side.

Just as there was no secret to Germany’s economic triumph, there will be no secret to its decline. Wages in the East have almost caught up to those in the West, and eventually the advantage in exports will disappear. The trading relationships in Central and Eastern Europe have been almost entirely exploited, and Vladimir Putin’s Russia is trying hard to pull those regions back into its economic thrall. The deutschmark is now an object of fond nostalgia. Two decades on, the boost from reunification is finally petering out.

This is natural. The size of every country’s economy depends on just two things: the size of its workforce and the productivity of its workers. Productivity, in turn, rests on the amount of capital available to each worker and how exactly he or she uses it. As a country settles into a path of steady growth, the "how" is what matters most. You can add and subtract capital and workers with all sorts of idiosyncratic events — reunification, war, natural disasters — but the long-term trend in living standards will always depend on the "how."

For Germany, the "how" has returned to center stage. Its every move in the current crisis will have tremendous implications not just for the euro area but for Germany’s future as well. It is on the cusp of changing its own economic institutions as well as those of the region. This is how you "improve competitiveness" for the decades to come — by shifting the deep legal, cultural, and even physical foundations of the economy, not just by tweaking a few regulations in the labor market.

If Germany seizes the opportunity to reconsider these deep economic factors, it will be able to alter permanently the trend — not just the level — of its people’s long-term living standards. This chance only comes along once in a very long while. For the East, it was reunification. For Germany as a whole, it is the euro crisis. With a little luck, Germany could finally throw some special sauce on that currywurst, rather than just dumping a quarter more hot dog onto the ketchup.