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A Bumpy Road Through the New Germany
(This article appeared in Stanford Business School Magazine in June 1992.)
As Hans-JYrgen MYller sped us through the circuitous streets of Berlin in his new Volvo, we felt a bit apprehensive. We were on our way to dinner at MYller's home in East Berlin, along with associate professor Bill Lovejoy and MBA classmate Takuji Kanai. Minutes before, MYller had picked us up at our West Berlin hotel, the Schweizerhof, and he was already bubbling over with questions, enthusiasm, and energy. His jovial mood contrasted with our alarm at his daredevil driving and our silence caused by the language barrier and the fact that we had no idea what we would encounter that evening.
We were part of a group students, accompanied by Lovejoy and Susanne Lohmann, who spent winter break visiting companies and government agencies in six cities in western and eastern Germany. The purpose of the trip was to learn firsthand about the economic restructuring of the former German Democratic Republic, to understand the implications of Reunification for both eastern and western Germany, and to spread the name and goodwill of Stanford. We found that as representatives of Stanford we were warmly greeted and hosted wherever we went. What we found out about the new Germany was less clear-cut.
Racing away from the glittering KYrfYrstendamm in West Berlin, we passed a large area piled with rubble. "This is where the Wall used to be," said MYller in German "Now it's the most expensive piece of real estate in Europe." We had just passed Potsdamer Platz, where Daimler-Benz is relocating its world headquarters. He pointed out elegant condominiums, in which the communist elite once lived, that now stand empty as rents have increased by as much as 200 percent.
Farther along, graffiti depicted a 20 foot-high image of former East German leader Erich Honecker lewdly embracing Brezhnev in a kiss, attesting to the anti-Soviet sentiment in the new Germany. The otherwise drab, colorless blur of the East was interrupted by the bright new signs of western gas stations and stores. As the contrasting images of old and new Germany flashed by our windows, we tried to piece together a coherent understanding of this land in transition.
From the outside, the house in which MYller lives with his wife and children looked as dilapidated as the others on the block. Inside it was spacious but simple. The furnishings had the parsimonious, plain, and outdated look of socialism. MYller wanted to show us something special that he had been working on. We followed him to the end of a long hallway lit by a single bulb hanging from a cord. MYller beamed with pride as he showed us a large, bright bathroom with modern western fixtures. Since he bought his prices around Berlin have almost doubled, contributing to MYller's enthusiasm about the future.
Over a plate of assorted wursts, we discussed Reunification and its tremendous impact on the MYllers. Hans-JYrgen recalled the days just following unification, when he decided to sell cured meats at the assembly plant where he worked. He recalled how anxious he was before he made his first sale. He could not predict how fellow workers would react to his bold entrepreneurial step. His entire inventory was at risk. On the first day he immediately sold everything he had. Customers were happy because they did not need to make the trek to the border for sausage from the West. MYller was elated. Soon he quit his job, bought a wurst trailer, and concentrated on his business. The profits have allowed the MYllers to enjoy a higher standard of living and have motivated Hans-JYrgen to take on more sophisticated projects.
The MYllers admitted that their success has caused them to lose many of their old friends. Jealousy and resentment toward those who seek profit are dividing communities in the East, but as the ebullient Hans-JYrgen enthusiastically related, "We are making a whole new set of friends based on our newfound freedom and the common will to shape our own destiny."
It was raining as our bus hurtled along the back roads of eastern Germany. We were headed toward Zwickau, home of Sachsenring Automobilwerk, makers of the Trabant automobile. We passed town after gray town. The countryside was dotted with tall chimneys puffing out sooty smoke from burning brown coal, the most plentiful and most polluting source of energy in the former German Democratic Republic. Suddenly, the phrase "smokestack economy" took on a precise meaning.
Zwickau, a city of 120,000 near the Czech border, was once the thriving center of East German car production. After the border collapsed, eastern Germans dumped their Trabants in favor of used cars from the West. German monetary union in July 1990 brought the hard deutsche mark to the East. Former Eastern Bloc trading partners could no longer pay for goods in hard currency thus isolating the East's automobile manufacturers. With the disappearance of their domestic and foreign markets, there was no choice but to stop production and shut down factories. Now managed by the state, Sachsenring stands 95 percent idle after layoffs of most of its employees.
"Not all of the body panels were made like this," said a veteran plant worker motioning toward the antiquated presses. "Some were made from steel." Assembly line tools stood frozen, with half-finished composite parts in their grip. Except for the tapping of rain, now leaking through holes in the roof, the vast factory was silent. We were at the idle stamping plant at Sachsenring, a place that seemed one step out of the Industrial Revolution. Built in the 1920s, the plant had received little care since the War. Poorly lit and ventilated, the building was coated with a pungent dust of yellow phenolic resin, used in making the Trabant's composite body shells. The working conditions were shocking. Unbelievably, replacement parts were still being made here as recently as last September.
Three million Trabants had been sold in East Germany since the 1950s, most at high prices to people who waited for as long as 17 years for delivery. The car's petite roundish features and noisy, smelly two-stroke engine are still unmistakable on the streets of East Berlin, Leipzig, and Magdeburg. There were never showrooms for the Trabi, as it was affectionately known, or gregarious car salesmen, or options, or low-interest financing. All distribution was handled out of a modest two-story building in Dresden that kept its business hours posted on the gate: "Accepting applications Thursdays from 9:30 to 11:45."
Back in the West the next day, we lunched at BMW's Munich headquarters and wondered what had gone wrong at Sachsenring. BMW used advanced robots, made in Germany, in its production of the 3-Series. Each car that rolled off the line was painted a different color, equipped with a slightly different engine, and tagged with a list of options specified by the customer. Why had Zwickau been left behind in the industrial Revolution, while Munich had charged ahead into the 21st century?
We found some of the answers in Berlin, at the Treuhandanstalt, the governmental trust authority responsible for privatizing, restructuring, or closing some 8,000 companies and 40,000 retail establishments that were formerly property of the East German government. So far, 5,000 companies have been sold at an astonishing pace—during our four-hour morning visit, eight companies were sold.
The Treuhand, located in a massive building that once served as Hermann Goering's Luftwaffe ministry, was bustling with consultants, bankers, company executives, and government officials. As companies and real estate changed hands, the building was undergoing renovation. We passed piles of rubble and workmen with drills as we walked down the long halls to our meeting room.
At the Treuhand, Dr. Eugen von Keller, of the consulting firm Roland Berger & Partner, explained investment opportunities in the East. Productivity in eastern German companies is low by western standards; their goods in most cases are not ready for export, nor are they competitive with imports. Local businesses—services and industries with natural barriers like transportation costs— are the most promising. Construction, building materials, brewing, consumer banking, hotels, newspapers, and distributorships are among the best positioned businesses. Businesses that will be difficult to salvage are ones in traditional, capital-intensive industries in which eastern Germany has no natural comparative advantages: automobiles, steel, raw chemicals, mining, and shipbuilding.
In the old centrally planned economy, generally only one company was allowed to exist in each major industry. The monopolies fostered by this policy had constant difficulties getting raw materials and therefore became vertically integrated to ensure a more steady stream of production supplies. These inefficient Kombinate, as they were known, employed a large portion of the workforce and contributed a major portion of the GNR Closing or radically downsizing the Kombinate—the economically logical decision—would increase eastern Germany's soaring unemployment, which reached 25 percent last year.
Under the old system, the majority of workers were employed in manufacturing and administration. Marketing was irrelevant because competition did not exist and the customer was unimportant. Controlling was unnecessary since there were no hard budget constraints. Managers had little sense of how much a product actually cost to make. One firm, Carl Zeiss of Jena, sold certain optical components at one-sixth of their true cost. Capital accumulation was stifled and investment suffered; this is why Sachsenring's facilities had hardly changed since the 1930s. The obsolete capital stock and inefficient operations of East German factories led to much lower productivity than that in the West. This productivity gap, coupled with scheduled wage increases to western levels by 1994, is a major obstacle to further investment and thus to the economic restructuring of eastern Germany.
The question, according to one German banker we met, is whether these structural disadvantages will cause eastern Germany to become "a big golf course" or one of the highest-tech new manufacturing sites in Europe. In other words, there is the possibility that the eastern states, with their low productivity and decrepit capital stock, could become irrelevant for manufacturing. Producers in the western states could simply expand capacity to serve this new market that comprises only one-fifth of the population of all of Germany. Eastern Germany could thus be relegated to a rural area, suitable for farming and recreation. On the other hand, with the $100 billion the government is investing annually, eastern German infrastructure will be redeveloped with the latest in telecommunications and transportation. This could provide a very attractive basis for future investment for new industries.
Overall, the Germans we talked with were in equal proportions optimistic and doubtful about eastern Germany's chances for rapid economic revitalization. The introduction of the capitalist system will have high short-term costs. The restructuring will bring changes, and the changes, pain. Whole industries could disappear or be radically scaled back, causing high unemployment for a time. Uncertainties persist about property ownership rights, clouded by the specter of restitution claims of pre-war owners that are to be honored. Unassessed environmental damage could prove vastly greater than has been seen in the West, bringing additional risks. As a consequence, much investment has been held back.
Nevertheless, our lasting impression was not of the skepticism that arises from a weighing of macroeconomic facts, but of the bubbling entrepreneurship of people like Hans-JYrgen MYller. It is he and Germans like him who will make it happen, who will speed the transition along, as if in tow behind his Volvo, bouncing and winding along the cobblestoned streets of East Berlin, but eventually reaching home.
