EAST GERMAN ECONOMIC MANAGEMENT: THE QUEST FOR EFFICIENCY
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Publication Date:
December 1, 1986
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Directorate of ~2C1Pe~
Intelligence
East German Economic Management:
The Quest for Efficiency
EUR 86-10046
December 1986
Copy 2 / 2
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Directorate of Secret
Intelligence 25X1
The Quest For Efficiency
East German Economic Management:
Office
Leadership Analysis, provided a biographical
contribution. Comments and queries are welcome and
may be directed to the Chief, East European
Division, EURA,
This paper was prepared b
of European Analysis.
Secret
EUR 86-10046
December ! 986
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Summary
!n/ormation available
as of 5 December 1986
was used in this report.
East German Economic Mana ement:
The Quest for Efficiency ~~ 25X1
decentralizing reforms.
East Germany, since the late 1970s, has made a series of changes in its eco-
nomic management that have generated improvements in efficiency, have
helped keep growth high by East European standards, and have prompted
rare public praise from Soviet General Secretary Gorbachev. East Berlin's
changes, for the most part, were administrative and organizational; tight
central control remains a hallmark of the economy. The East Germans
managed the improvements apparently without ever seriously considering
ment resources.
Key to the effort to improve efficiency was the reorganization of industry.
In 1979, after several years of study, the East Germans restructured
industry in an effort to overcome the common problems of centrally
planned economies: inefficient use of energy and raw materials, low capital
and labor productivity, planning and coordination problems, and poor use
of investment resources. The government reorganized all of the centrally
controlled industrial enterprises into about 130 Kombinate, or combines.
The directors-general of the combines were given broad authority over
operations and were made personally responsible for performance. The
large, streamlined entities, it was hoped, would benefit from economies of
scale, leadership by managers of proven ability, better interenterprise
coordination, and improved use of investment and research and develop-
As external pressures on the economy grew more severe in the early 1980s,
additional changes were made in policies and organization to promote
exports, productivity gains, and the more frugal use of production inputs:
? In 1981, East Berlin reorganized the foreign trade apparatus, increasing
the emphasis on exports and tightening the links between foreign trade
enterprises and the industrial concerns they directly serve.
? After years of public complaints about the sluggish performance of
agriculture, East Berlin in 19841aunched an agricultural price "reform,"
featuring sharply higher producer prices for farm products and reduced
subsidies. It also made a series of organizational changes designed to
improve the management of farms.
Secret
EUR 86-10046
December 1986
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? East Berlin directed its limited investment resources toward the modern-
ization of old, rather than the construction of new, plants and toward a
few key projects in order to bring new capacity into operation more
quickly.
? The regime boosted financial incentives for both workers and combines,
offering the prospect of larger bonuses and increased resources for better
work, and penalties for poor production.
? East Berlin shifted the criteria for judging enterprise performance-and
determining bonuses for workers-toward profitability, net output (gross
output less inputs), and exports.
? The regime moved to improve the administration of the economy by
issuing directives to change specific enterprise practices and modifying
the planning process to accommodate organizational changes. It also
tightened oversight of the economy, in some cases.
Data on economic performance
indicate that the changes in economic management have general-
ly paid off. Since the region's economic and financial crisis of the early
1980s, East Germany has been the most successful East European country
in reviving economic growth, strengthening its hard currency financial
position, improving living standards, and reducing trade deficits with the
USSR. By East German measures, produced national income grew an
average of 5.2 percent in 1984-85 versus 2.6 percent in 1982, while
Western estimates show GNP rebounding from no growth in 1982 to an
average of 2.8 percent the past two years. The regime has reported-and
our analysis confirms-renewed growth in productivity and steady reduc-
tions in production costs. We calculate that while energy consumption was
1.1 percent higher in 1984 than in 1980, industrial production was 8.4
percent higher. East Berlin has run hard currency trade surpluses since
1980 of about $1 billion annually, on average, and cut net debt roughly in
half, rekindling enthusiasm among Western bankers to lend to East
Germany. Official statistics for the first 10 months of 1986 suggest that
East Germany has begun its new five-year plan period on the right foot;
growth of national income remains above 4 percent and most industrial
sectors exceeded targets
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In sum, organizational changes have made it possible for East Germany
better to take advantage of two important assets-special trade and
financial links to West Germany and swell-educated, well-disciplined
work force-and have brought about a notable economic turnabout since
the early 1980s.
Despite the achievements, some of East Berlin's actions have probably been
counterproductive, others were not as successful as hoped, and key
problems endemic to centrally planned economies-such as distorted
prices-have not been addressed. The combine reorganization, for exam-
ple, may have reduced the initiative of factory managers to innovate.
Altered performance criteria may be encouraging the inefficient produc-
tion of consumer goods and the costly, extended use of obsolete capital
goods. East German officials publicly admit that the planning process
could be further improved. The GDR has not decided on a genuine reform
that would set prices at their economic cost-a key to improving resource
allocation in the economy.
Given the comparative success of current policies, the East German
leadership seems unlikely to alter its economic strategy, particularly in
favor of decentralizing reforms. Party leader Honecker said in 1985 that
the economy is no place for "experiments" and he remains firmly in
control. While problems remain, and a successor to the 74-year-old
Honecker could want to make changes, we expect no significant alteration
in the basic economic course before the next Communist Party Congress in
1991. Instead, the East Germans are likely to continue to tinker with
aspects of the economy to redress perceived problems and improve
efficiency.
Nonetheless, with tightening resource constraints at home, continuing
Soviet economic pressures, and completion of many of the easy organiza-
tional fixes, East Germany will have to look to new areas to keep
productivity on the rise and growth stable. The East Germans are banking
on improvements in science and technology linked closely to industry to be
the main motor of growth. We expect that the East Germans will be able to
generate additional efficiencies through modernization and better organi-
zation, planning, and management. This should keep growth strong by East
European standards even if the economy continues to lag the more
advanced Western countries.
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East Germany's comparative success in recent years has prompted some
observers to wonder whether its experience offers a "model" that other
socialist countries could profitably emulate. We believe that some of East
Berlin's practices can be borrowed successfully. However, the government's
actions were designed to correct particular East German problems, and the
unique institutional characteristics of a relatively small economy suggest
that most policies are not easily replicable in other CEMA countries. Even
the USSR, whose leaders have been most outspokenly complimentary of
East German domestic economic management, has yet to borrow signifi-
cantly from East German experience. Despite Gorbachev's praise, many
Soviet economists say that any eventual Soviet emulation of East German
economic practice will be modified by particular Soviet needs and national
institutions.
Continued improvements in the efficiency of the its economy will keep East
Germany an economic power in CEMA and help East Berlin support
Moscow's domestic economic programs. East Germany should-despite
recent friction over bilateral trade relations-maintain its position as the
largest trading partner of the Soviet Union and as a technological leader
within CEMA. Improvement in export competitiveness, despite recent
losses from the decline in oil prices, probably will keep East Berlin in hard
currency trade surplus and keep the GDR a favorite of Western bankers.
Finally, a continued example of East German prosperity could help spur
other East European regimes to redress clear economic ills, further
contributing to the strength of CEMA and the power of the Warsaw Pact.
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Impetus for Change
The Role of Combine Management 7
The Foreign Trade Reorganization 9
Investment Policy and Management 10
Regulatory Changes 16
Stability Amidst the Change 16
The Future and Its Challenges 25
Serious Challenges Remain 26
Modernization and Restructuring 27
Appendixes
B. Party/Government Economic Management Links
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Scope Note This paper discusses changes in the management of the East German
economy that we believe have contributed in recent years to the improved
efficiency and relatively strong performance of the economy, by CEMA 25X1
standards; it is not intended to be a text on the organization of the East
German economy or socialist economies in general. We focus on the impact
of the changes on East German performance and generally do not discuss
the applicability of GDR economic management practices to other Com-
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East German Economic Management:
The Quest for Efficiency
The East German economy has performed well in
recent years, by Communist country standards. Fol-
lowing stagnation and a near financial crisis in the
early 1980s, East Germany has recorded healthy rates
of economic growth and sizable hard currency trade
surpluses, has reduced its debt, and now enjoys a solid
international reputation for creditworthiness. Senior
Soviet leaders, including General Secretary Mikhail
Gorbachev, have praised East German economic
management, particularly the Kombinat, or combine
system of industrial organization, despite apparent
differences over bilateral trade relations.' East
Germany's emphasis on streamlining central plan-
ning, while maintaining tight central control of indus-
try, apparently appeals to the Soviets because it is an
attempt to improve the present system without the
political risks of decentralizing reforms. Some West-
ern and Eastern observers have even speculated that
the East German experience may offer examples to
the Soviets and other socialist states of ways to
improve their economies
In making the East German economy the most solid
among CEMA countries, the GDR leadership has
benefited from two important assets: special trade and
financial links to West Germany and awell-educated,
well-disciplined work force.2 Nonetheless, we believe
' Gorbachev's praise of the GDR was strong and clear. His
comments, in May and June 1985 and again at the East German
Communist Party Congress in April 1986, focused on industry
including productivity gains, product quality, and the application of
new technology in production. Senior economic adviser Abel Agan-
begyan also has praised the GDR. Major Soviet publications,
including Pravda and tzvestiya, further highlighted Soviet interest
in East German industrial organization by printing lengthy articles
by senior East German officials, including Honecker and economic
"czar" Mittag, on GDR economic management and performance.
East Berlin's efforts to improve economic manage-
ment through organizational changes have not only
made it possible to take better advantage of these
assets but are the major reason for East Germany's
recent economic turnaround and success in meeting
Soviet economic demands. This paper assesses the
GDR's efforts to improve the efficiency of its econo-
my and examines the challenges of the next several
years. See appendix A for a description of data on
East German economic management.
The current economic management system and poli-
cies originated with Erich Honecker's replacement of
Walter Ulbricht as party leader in 1971. The Eighth
Congress of the Communist party (Sozialistische
Einheitspartei Deutschlands, or SED) in June 1971
adopted two new economic "main tasks"-rapid
growth and improving the living standards of the
population. It rejected Ulbricht's faltering program of
modest decentralization, the New Economic System
(NES), and reimposed tight central control over most
facets of the economy.
East Berlin generally succeeded through the early and'
middle 1970s in achieving the "main tasks." We
estimate that real GNP growth averaged 3.5 percent
annually during the 1971-75 plan period and that
consumption rose steadily. Honecker's policies, how-
ever, ignored and even aggravated fundamental prob-
lems common to centrally planned economies:
? East German industry remained inefficient, and
both labor and capital productivity were markedly
lower than in the West.
? Official statistics showed that factories consumed
much larger quantities of increasingly costly energy
and raw materials per unit of output than their
Western counterparts.
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The New Economic System of Guiding and Managing
the National Economy (NESJ was the GDR's only
attempt at reform of central planning. Instituted in
July 1963, the NES incorporated many of the ideas
of the Soviet economist Evsei Liberman and was the
.first program of decentralizing economic reforms in
the Soviet Bloc. It partially dismantled direct admin-
istrative control, such as obligatory plan production
quotas, and instituted a system of direct financial
controls and incentives known as economic levers.
This ejfectively granted enterprises more decision-
making autonomy, while retaining overall central
control. Profit became a major success indicator. It
was hoped that the use of suitable guidance and the
exploitation of the sell-interest of both individual and
enterprise would boost efficiency and growth.
Problems soon emerged, however, as decentralization
brought coordination dl,~culties. The economic le-
vers were not working as hoped-they sometimes led
to wasteful use of resources, for example-and con-
flicts between central authorities and the more auton-
omous enterprises developed. The regime, we believe,
was unwilling to part with the political control that
was part of the decentralizing economic reform. East
Berlin grew increasingly disappointed with the NES's
failure to generate significant gains in economic
growth and living standards. Recentralization set in
cjlter April 1968-even before the Warsaw Pact inva-
sion of Czechoslovakia in August made economic
reform still less politically attractive-and the NES
gradually faded away. Honecker's assumption of
power, in April 1971, helped move economic policy
away from the increasingly discredited system firmly
associated with his predecessor
The clearest warnings of East Germany's economic
weaknesses were burgeoning foreign debt and a slow-
down in growth in the late 1970s. Chronic hard
currency trade deficits pushed East Germany's net
debt from an estimated $1 billion in 1970 to $11.6
billion in 1980. During the last half of the 1970s, the
GDR also swung into chronic deficit with its largest
trade partner, the USSR, as Soviet oil and natural
resource prices gradually reflected rapidly rising
Western prices. Nevertheless,
East German leaders showed little concern
about the GDR's lack of efficiency and international
competitiveness so long as growth remained strong,
living standards rose, the Soviets kept increasing
deliveries of raw materials, and Western banks were
willing to lend to cover trade deficits. By the late
1970s, however, economic performance fell below
plan as GNP growth averaged 2.4 percent annually in
the period 1976-80. The senior political leadership
came to realize that lagging productivity, rising costs,
and mounting debt could not continue indefinitely,
and the regime began to address the economy's
inadequacies.
East Berlin's institutional and administrative changes
in the late 1970s were intended only to modify the
existing economic system and to push growth back to
the levels originally planned for the period 1976-80.
The perceived inadequacies of the NES and the
potential political dangers of decentralization helped
dissuade the Honecker regime from emulating
Hungary's market-oriented reforms. Moreover, the
Honecker regime chose not to follow Hungary's
strategy of a deliberate slowdown in economic growth
and consumption gains to adjust to its debt problem.
Instead, East Germany's 1981-85 plan directive
largely retained the macroeconomic goals from the
1976-80 plan and called for gains in productivity and
efficiency to provide the impetus for faster growth.
? Investment resources often were poorly used and the
regime's efforts to boost efficiency and productivity East Germany's increased emphasis on efficiency
by scientific and technical innovation lagged. reflected the regime's awareness of the constraints on
? The rigidities of central planning discouraged inno-
vation, inhibited export competitiveness, and con-
tributed to a foreign trade apparatus that, according
to Western businessmen, was notoriously unrespon-
sive to changing market conditions.
the economy's growth potential. Limited domestic
resources-including a steadily declining population
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East Germany: Chronology oJSigni,/icant
Economic Events
1 /July 1963 Introduction ojthe guidelines for the "New
Economic System ojPlanning and Manage-
ment for the National Economy. "Only com-
prehensive economic reform in East German
history. NES gradually jaded away in the
late 1960s.
June /97/ Eighth Communist Party (SED) Congress.
Honecker changes economic strategy, estab-
lishes growth ojeconomy and personal con-
sumption as "main tasks."Recentralization
continues.
1971-73 Much ojprivate enterprise nationalized. The
rest is restricted.
Late /970s Regime slowly recognizes need for improve-
ment in eJj'iciency and reduction ojtrade
deficits.
8 November 1979 Decree mandates conversion ojAssociations
ojPeople's Own Enterprises, or VVBs, to
Kombinate (combines) ejl'ective l January
1980.
Foreign trade enterprise reorganization
announced.
10th SED Congress adopts Economic Strate-
gy ojthe 1980s.
Martial law declared in Poland. GDR nears
liquidity crisis shortly thereafter as bankers
react to Western sanctions. Vigorous domes-
tic adjustment begins.
Regime imposes austerity and issues steady
stream ojnew regulations.
1 January /984 Seventy-percent tax on wagejund-called
contribution to social funds-imposed on in-
dustrial firms.
l January 1985 Seventy-percent wage tax extended to con-
struction enterprises.
June 1985 Honecker announces new domestic S&T ini-
tiative, including separatejive-year plan.
January 1986 Capital price revaluation. Exact amounts
unspecified.
April 1986 I /th SED Congress announces 1986-90 plan
directive and confirms current economic
strategy.~~
and comparatively few natural resources-as well as
declining growth in Soviet energy and raw materials
deliveries left little alternative but to abandon "exten-
sive" growth-increased production using more in-
puts-in favor of "intensive" growth resulting from
increases in efficiency.
Events beyond East Berlin's control added even great-
er impetus to regime efforts to improve efficiency and
competitiveness in the early 1980s. Western bankers,
already concerned by the buildup of debt of East
European countries including East Germany, reacted
to Poland's bankruptcy and heightened East-West
tensions after the imposition of martial law in Decem-
ber 1981 by cutting back lending to Eastern Europe.
By early 1982, East Berlin was forced to impose
severe austerity measures, to increase exports at
almost any cost, and to accelerate efforts to cut
production costs in order to avoid financial insolvency.
The regime had to subordinate, at least temporarily,
growth and improvements in living standards to re-
payment of debt and maintenance of balanced
trade-a significant change in economic priorities. At
the same time, East German terms of trade with the
USSR continued to deteriorate even as the Soviets cut
raw materials deliveries, including oil, and demanded
that the GDR reduce its trade deficits.
To deal with its economic problems, the government
made changes in industrial organization, pricing, in-
centives, and regulations that guide economic decision
making. The regime increased emphasis on scientific
and technical progress as a motor of economic growth.
The regime also made changes in the planning mecha-
nisms to reflect the organizational changes and ad-
dress perceived weaknesses.
The separate changes were not part of a single
comprehensive plan such as the NES. Instead, they
emerged largely in piecemeal fashion from the "eco-
nomic strategy of the 1980s," a 10-point directive to
"rationalize" the economy promulgated by the 10th
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The Economic Strategy oj, the 1980s
The East German Communist Party, or SED, un-
veiled at its 10th Congress in 1981 and re~irmed S
years later a 10 point "economic strategy for the
1980s"that was designed to move the economy from
`extensive" growth to "intensive" growth by improv-
ingthe e,~ciency oj'the economy. The list of goals
represented a series of overlapping ambitions rather
than a coherent, integrated plan like the New Eco-
nomic System. The individual points represent, how-
ever, constant public themes oj" the East German
leadership and show where the regime is devoting its
human and physical resources.
According to Honecker in his Central Committee
report in April 1986, the strategy includes:
? "Linking even more effectively the advantages of
socialism with the scientific-technical revolution."
He singled out microelectronics and computers as
areas that "increasingly determine the perjorm-
ance" of the economy.
? Accelerating the growth of productivity and gener-
ating 90 percent of'overall economic growth jrom
productivity gains.
? Cutting the use of energy and materials in
production.
? Improving the quality of output.
SED Congress in April 1981. Almost all of East
Berlin's actions have amounted to administrative
changes, which do not constitute reform in the sense
of changing the mechanisms by which resources are
allocated in the economy. Central authorities-the
government and party leaderships-have continued to
make the key decisions on how economic resources are
used, and market forces play only a small role in
determining the production and distribution of goods.
In some cases, moreover, individual economic
decision-makers, such as the enterprise directors, have
lost freedom of action.
? Giving a `prominent place to socialist rationaliza-
tion."The regime wants to improve the efficiency of
production through better industrial organization.
? Increasing the "e.~ciency of labor. "This involves
using capital to increase e.~ciency as well as pro-
viding avariety of labor incentives to boost produc-
tivity, such as those currently in ejject under the
`Schwedt Initiative'=named after the oil refining
and chemical combine at Schwedt.
? Increasing the ejjectiveness oj' investment by im-
provingthe planning and management of investment
projects.
? "Greater ...production oj'consumer goods."
Quality is to improve and every combine must
contribute. The directive is intended to support
Honecker's consumerist policies and to meet Soviet
demands for greater consumer goods deliveries.
? Gearing the economy toward "continuous and dy-
namic growth of performance. " A relatively nebu-
lous directive, the regime means to improve its
human capital by boosting education and encourag-
ing creativity.
? Pushing the application oj'science and technology
to all segments of society.
The most important changes have occurred in indus-
try. In November 1979, after several years of experi-
mentation, the parliament (Yolkskammer) issued a
decree reorganizing all centrally controlled industrial
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Figure 1
East Germany: Industrial Organization
Before and After the Combine Reorganization
State Planning
Commission
single combine director-general (see figure 1).
enterprises into Kombinate or combines.' The reorga-
nization created large, generally vertically integrated ,
monopolies that control all phases of production for a
given type of output from resource extraction to final
assembly. This involved putting several "People
Owned Enterprises" (Volkseigene Betriebe, or VEBs)
that generally were engaged in different operations
and research organizations under the control of a
' In this paper, we use the English term combine-an association of
groups united for the furtherance of commercial interests. Under
this definition, East German combines resemble somewhat the
combines, or trusts, of the 19th-century capitalist West. The decree
in 1979 accelerated the use of the combine organization and
modified command relationships, but did not create the institution;
the combine was mandated under a decree in February 1967 as part
of the NES. Some industries were organized as combines through-
out the 1970s.~~
Carl Zeiss Jena:
A Model Combine
East German leaders tend to single out the Kombinat
VEB Carl Zeiss Jena (CZJ) as the model industrial
combine. Looted and completely destroyed by the
Red Army immediately 'ter World War II, CZJ
reassembled those employees who did not jiee to the
West and became one of the GDR's most technologi-
cally advanced combines. It is widely regarded as a
world leader in some technologies, particularly op-
tics. The combine sells extensively in the West and
acquires Western technology. The combine also as-
sists the USSR in a variety of areas, including
supplying photo reconnaissance cameras and military
optics such as night vision devices and laser range-
finders. In recent years, CZJ has moved into the
microelectronics field.
CZJ had 24 subordinate enterprises and 69,000
employees in mid-1986, making it one of the largest
enterprises in the country. CZJ in early 1986 had two
research organizations with 7,500 employees, a close
working relationship with the Friederich Schiller
University of Jena, and a wholly subordinate foreign-
trade enterprise (with a branch o,~ce in New York
City.J The combine is one of only a hancl/'ul autho-
rued its own hard currency account-a reward for its
superior export performance. CZJ has another major
advantage: Director-General WoUgang Biermann is a
son-in-law of Premier Willi Stoph and a full SED
Central Committee member. This presumably gives
him extra clout when party decisions are made on
resource allocations.
CZJ displays many of the characteristics the party
leadership is trying to foster throughout the economy,
and it often is used as a standard of comparison. In
January 1986 the combine received lengthy, front-
page praise in the Communist party newspaper Neues
Deutschland. Honecker had glowing words during a
visit to one of its plants in May 1986. Praise typically
centers on CZJ s.?
? Technologically advanced, high-quality output.
? Success at exporting to the West and socialist
countries.
? Steady growth and rapid increases in productivity.
? Close working ties between researchers and the
factory jloor.~~
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Table 1
East Germany: Centrally Controlled Industrial Combines
Year Number
of Combines
Industrial
Commodities
Work Output of Finished Exports
Force Consumer Products
Source: Statistisches Taschenbuch der Deutschen Demokratischen
Republik, 1986.
Once mandated, the combine organization spread
quickly. According to official statistics, the number of
combines in centrally controlled industry rose from 54
in 1978 to 133 in 1981, when all such industry-
including 4,332 VEBs and nearly 3.2 million work-
ers-was reorganized (see table 1).? The regime then
began to reorganize centrally controlled construction,
transportation, and communications industries and
district (Bezirk) controlled industry, which includes
? By the early 1980s, combines had been created or reorganized in
five ways:
? VVBs-or Associations of People's Enterprises-were renamed
combines, with or without adding enterprises.
? Two.or more existing combines merged.
? An existing combine absorbed more VEBs.
? An existing combine was resubordinated to another ministry as a
nucleus of a new combine.
? Existing single-enterprise combines were left alone.
The new combines varied considerably in structure,
including:
? Vertical monopolies-single producers of products controlling
their own supplier enterprises such as the optics maker Carl Zeiss
Jena.
? Horizontal monopolies producing all of some products but with-
out control of their suppliers.
? Oligopolies of several combines in an industry--chemicals, for
much smaller enterprises.s By yearend 1985, the total
number of centrally controlled combines stood at 156,
while districts managed 93 combines in late 1985.
Centrally controlled industrial combines typically
have 20 to 40 VEBs and have, on average, about
25,000 employees; the largest has about 70,000 per-
sonnel. ~~
The East Germans believed the large groups would
increase efficiency by generating economies of scale,
pooling managerial talent, focusing investment on
specific production tasks, reducing administrative re-
dundancies, and streamlining decisionmaking. The
combine structure would foster risktaking and innova-
tion because a large, wealthy entity could afford
occasional losses resulting from single mistakes. The
East Germany is subdivided into 15 Bezirke, or districts, which
contain 228 Kreise, or counties. The district is the smallest political
unit controlling economically important institutions, though the
counties offer some economic services such as employment offices.
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concentration of human and material resources under
leaders of proven management ability would give
constituent enterprises access to larger investments
and better management services than they could
secure on their own. It also would improve interenter-
prise coordination and facilitate planning through
better information management. Whereas VEBs per-
forming different functions had been previously sub-
ject to the planning, resource allocation, administra-
tive and marketing prerogatives and procedures of
several ministries, reorganization into a single com-
bine made them responsible to only one ministry. This
concentration of enterprises would reduce the need for
interministerial coordination, speeding the flow of
information toward the center and horizontally
among enterprises and combines.
The regime expected that the subordination of re-
search and development organizations to combine
management would link these capabilities more di-
rectly to the needs of production enterprises. The
GDR particularly hoped that the combine directors-
general could bring about a more direct involvement
of research talent in production in order to develop
new technologies that would boost labor productivity.
This is a key concern in an economy with a falling
population and an already high labor force participa-
tion rate. Accelerated product development is also
essential for a country that must compete on the
demanding, rapidly changing world market for manu-
factured goods and respond to Soviet demands for
higher quality exports.
Altered Command Links
The reorganization markedly changed command rela-
tionships within industry and modified the mix of
centralized and decentralized management in the
East German economy:
? Central authorities-including the Council of Min-
isters and State Planning Commission-retained
the authority to set plan targets and control
resources.
? The VVBs (Vereinigungen Volkseigener Betriebe or
Associations of People's Enterprises) that had loose-
ly linked similar enterprises and combines but had
limited operational authority were abolished. Pri-
marily an administrative body, the VVB did not
have the legal standing to direct the activities of
associated enterprises and thus could not deal with
the coordination and supply problems endemic to
centrally planned economies.
? The combine directors-general were given markedly
greater authority over enterprise operations at the
expense of both the ministries and VEB managers.
The removal of central authorities from day-to-day
operations reduced their ability to micromanage
while the role of enterprise managers in policymak-
ing was reduced to that of providing information.
? Although they have lost influence in setting eco-
nomic priorities, enterprise managers retained ma-
jor operating authority at the shop level that is
beyond the day-to-day control of the ministries and
combine directors-general.
? The subordination of research and development
assets to the combines reduced the role of the
ministries and the Academy of Sciences in financing
and directing industrial S&T development.
The abolition of the VVBs and the strengthening of
combine management's powers over VEBs have effec-
tively reduced the number of major bureaucratic
levels within economic management from five to
three: the Council of Ministers, industrial ministries,
and combines. The East Germans see this structure as
a way to secure the benefits of partially decentralized
operational management without relinquishing cen-
tral control over basic policy and resource allocations.
The Role of Combine Management
The reorganization made the combine directors-
general the crucial actors in the management of East
German industry. They received significant new
authority over resources and commensurate responsi-
bility for their combines' performance. The directors-
general were given considerable freedom to direct,
change, or reorganize combine operations and move
human, physical, and financial assets within their
combines. This includes the authority to assign tasks
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to VEBs, create new VEBs, and transfer tasks be-
tween these enterprises. They were charged with
fostering innovation and the introduction of new
products within general guidelines set by planning
authorities. They authorize bonuses and have de facto
authority to lay off workers deemed redundant despite
the constitutional guarantee of a job for all. The
changes made the directors-general, in essence, both
limited entrepreneurs and agents of their industrial
ministers responsible for plan fulfillment.
The VEB directors became operating managers sub-
ordinate to the directors-general. In this respect,
VEBs came to resemble somewhat the operating
divisions of large Western corporations-with invest-
ment, personnel transfers, and product lines subject to
the authority of "headquarters management"-even
though they retained legal status as independent
firms. To solidify the control by the directors-general
the regime gave many of them a second hat as
director of the Stammbetrieb, or main enterprise, of a
combine. These large VEBs often account for a large
share of the employees and much of the production of
heavy industrial combines.b
Changes in the planning process in the early 1980s
explicitly made the directors-general focal points in
the flow of information and planning, including the
determination of goals and allocation of investment,
capital, labor, and financial resources within the
combines. The directors-general are expected to take
the initiative during the planning process to broker the
interests of subordinate enterprises, the supervising
ministries, and themselves. Enterprise wants and
needs are communicated to planning authorities and
the Council of Ministers through the combines, while
orders and resources flow back down. To improve its
chances of plan fulfillment, combine management
must ensure, during plan negotiations with its minis-
try and the planning commission, that its goals are
realistic and that it has the resources to accomplish
tasks set by the central authorities.
b These large enterprises exist mainly in industries that require
great capital investments and can achieve economies of scale in
single large plants. The Stammbetrieb of VEB Gaskombinat
Schwarze Pumpe, the lignite processing and gasification combine,
employs over half of the combine's workers. The other VEBs
transport gas and operate smaller plants that have a narrower range
The increased power of combine directors-general,
often buttressed by membership in the SED Central
Committee, comes close, in some Western observers'
views, to rivaling the authority of the industrial
ministers. These observers speculate that this en-
hanced authority harbors the potential for disruptive
power struggles and ultimately may lead to the
abandonment of the combine as an industrial struc-
ture. The ministries, however, have retained the
means to control the activities of combine manage-
ment, and we do not have any evidence of ministry-
combine conflict. Moreover, we believe that the party
would move quickly to nip in the bud any such
conflict.
Although the combine directors-general have consid-
erable freedom to change operations at the factory
level, they function within some tight institutional
bounds in formulating broader strategies. Major in-
vestment projects and hard currency allocations are
controlled by the Council of Ministers, State Planning
Commission, and party; wages and prices generally
are fixed by central regulation; broad production-mix
objectives are centrally determined (albeit with the
combine management's input); and the state commits
large amounts of output to export to socialist coun-
tries under long-term contracts.
The regime clearly hoped that the reduction in levels
of bureaucracy and greater centralization of power in
the hands of combine directors-general would produce
advantages that would outweigh the disruptions from
change. The new organizational structure allows
greater flexibility to respond to perceived weaknesses,
new needs, and changing resource availabilities. Com-
bine directors-general regularly merge enterprises and
create new VEBs within their combines to meet
demands. Official statistics show a net loss of 679
VEBs between 1981 and 1984, to 3,653, as industry
continued to consolidate. By early 1986, according to
the GDR press, the regime also reduced by six-to
127-the number of combines via the merger route.
For example:
? Kombinat VEB Pentacon of Dresden, a maker of
cameras, was dissolved and its assets resubordinated
in January 1985 to optics maker Carl Zeiss Jena,
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the move was designed to boost CZJ's
capacity for military-related production. It was also
apparently intended to eliminate redundant R&D
efforts.
? The East Germans on 1 January 1985 deactivated
VEB Kombinat Elektroanlagen Leipzig (an electri-
cal equipment maker) and combined its assets with
VEBs from other combines including VEB Trans-
Jormation and VEB Kombinat Automatisierungs-
anlagenbau, headquartered in East Berlin. The
move apparently was a part of the government's
push to develop higher technology goods by combin-
ing the firms' research departments.
The GDR's continuing emphasis on centralizing re-
search and production operations in large monopolies
argues that the Honecker regime is generally satisfied
with the combine form of industrial organization.
To complement the combine reorganization and ad-
dress the problem of burgeoning debt to the West,
East Germany instituted major changes in the struc-
ture of foreign trade enterprises (FTEs).' Although
deteriorating terms of trade and domestic economic
inefficiencies contributed to poor hard currency trade
performance, the FTEs-all subordinate to the Minis-
try of Foreign Trade and not accountable to the
industrial concerns they served-were widely regard-
ed as out of touch with domestic industry and foreign
markets. the
FTEs were slow to respond to changing Western
market conditions and were notoriously poor in pro-
viding customer service.
At the beginning of 1981, the regime moved to
improve links between producers and foreign markets
by:
? Creating 24 new foreign trade enterprises and sub-
ordinating them to combines. These enterprises
' The FTEs are primarily involved in trade with the West. Agree-
ments and contracts with socialist countries often are handled at
the government-to-government and ministry-to-ministry levels and
became marketing arms and purchasing agents 25X1
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Combine management received greater supervisory
authority over foreign trade officials with the goals
of securing more timely and complete information
about trends in Western markets and exercising
better control over combine resources to meet cus-
tomer service requests.
? Resubordinating some 20 other FTEs (subdivided
into 61 foreign trade sections with each supporting
one combine) to both the Ministry of Foreign Trade
and one of the 11 industrial ministries.8
As a result of these changes, the FTEs now provide
Westerners with explicit single points of contact for
individual industrial sectors.
Despite the increased authority in foreign trade activi-
ties given combine managers, the operational preroga-
tives of the FTEs and hence of the combines remain 25X1
circumscribed. The State Planning Commission and
the Council of Ministers continue to exercise the
traditional state monopoly over foreign trade by con-
trolling hard currency authorizations and receipts.
The FTEs generally lack the authority to trade on
their own account.9
Although the dual subordination of many FTEs vio-
lates the managerial principle of unity of command,
the East Germans implemented the change to facili-
tate communications. Contact with the trade ministry
ensures compliance with overall national foreign trade
objectives, while subordination to an industrial minis-
try ensures the FTE supports the ministry's combines.
e The GDR left in place a few non-industry-specific FTEs, such as
the general trading firm Intrac, and service enterprises directly
responsible to the Ministry of Foreign Trade. Intrac is a special
case in other ways: it has wide latitude to use foreign exchange and
borrowing authority, can operate worldwide and trade in all
The East Germans did not change the status of
four FTEs responsible for coal, lumber, and electrical energy trade.
A final foreign trade variant involves combines without subordinate
FTEs that were allowed to conduct some business on their own.
' peS cial hard currency accounts, funded by a part of their own
earnings, are authorized for only a few combines as rewards for
particularly large exports to the West.~~
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Figure 2
East Germany: Command and Commercial
Links of a Typical Foreign Trade Enterprise
Flows of goods
Commands
Communications
Contracts
Ministry for
stry
Ministry for
Foreign Trad
Western
markets
c:nemte
Export-Import
hemical
combines
This schematic represents the relationships between the foreign trade
enterprise Chemie Export-Import and its Western customers, two superior
ministeries, and the chemical combines it serves. The Foreign Trade
Enterprise (FTE) receives commands and funding from its ministries.
It procures in [he West for its combines and markets their products
abroad. If service is required by a Western costumer, the FTE gets
technical expertise,which it may no[ have,from a combine. The combines
themselves do no[ contract directly with Western firms.
Access to ministerial authority allows the FTE direc-
tor to requisition combine resources -service repre-
sentatives, for example-not otherwise automatically
available. The command links of a typical foreign
trade enterprise, Chemie Export-Import, are shown in
figure 2.
East German officials maintain that the dual subordi-
nation does not cause managerial conflict. Chemie
Export-Import officials have told US Embassy Berlin
officers that the FTE's thousand or so employees are
not buffeted by opposing commands from combines,
the Ministry of Foreign Trade, and the Ministry for
Chemical Industry. Indeed, the East Germans
maintain that the structure ensures harmony by mak-
ing both relevant ministries responsible for fulfilling
the foreign trade plan and eliminating the possibility
that one could blame problems on the other
The government has taken other steps to improve the
performance of the FTEs.
FTE employees are receiving better training in
Western marketing and customer service techniques
and getting more foreign travel opportunities. The
regime is also encouraging expansion of the semian-
nual Leipzig Trade Fairs.
Changes in Policies and Controls
In addition to the industrial reorganization, the Hon-
ecker regime in the early 1980s instituted a number of
changes in investment management, worker incen-
tives, planning and performance criteria, and adminis-
trative regulations. Some of these changes were to
accommodate the combine reorganization and to take
advantage of its perceived advantages. Other changes
responded to the heightened external economic pres-
sures on East Germany caused by the East European
financial crisis and toughening Soviet trade require-
ments.
Investment Policy and Management
East Berlin modified its investment strategy in order
to reflect its hard currency constraints and its shift
toward "intensive" growth by seeking to
"rationalize," or increase, the effectiveness of invest-
ment. The government cut back new investment,
focusing more on earlier completion of continuing
projects and modernization of existing plant and
equipment. The result was a reported 9.9-percent
decline in investment (in constant prices) from 1981 to
1984 before a 3.7- percent rise in 1985. As the volume
of investment fell, the regime reallocated investment's
diminishing share of national income. Energy-par-
ticularly lignite development-and key manufactur-
ing sectors, like machine building and electronics, got
the largest portion. Domestic trade, transport, and
communications received declining amounts. Agricul-
ture's take fell 23 percent between 1980 and 1984,
10.6 percent between 1983 and 1984 alone-a decline
we attribute largely to the reduction in subsidies
associated with the agricultural price reform (see
inset). In addition, official statistics show that the
construction share of overall investment is dropping as
the regime concentrates on purchases of equipment.
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The unprecedented agricultural price reform and
organizational changes implemented in East
Germany on 1 January 1984 reflected the regime's
longstanding unhappiness with the performance of
agriculture. Output of key commodities had stagnat-
ed and grain imports of roughly 3 million metric tons
annually had become a major drain on hard currency
reserves. Reported productivity was low, the govern-
ment acknowledged wasteful use of fertilizers, and
repeated regime exhortations for increased worker
effort failed to evoke a sign cant response.
The 'price reform, " as it is widely known, introduced
major pecuniary incentives into agriculture. The re-
gime sharply boosted procurement prices for a broad
variety of agricultural products, typically by 60 to 80
percent, It promised
that increased output would be rewarded by higher
farm profits and higher bonuses for managers and
workers. The reform also rewarded small private
producers-those farming in small, state-provided
garden plots-with extra large increases in state
procurement prices for fruits, vegetables, and even
rabbits, which are especially prized by consumers.
The government lurther encouraged small farmers by
granting preferential access to supplies of seed and
fertilizer from state stocks. The decree did not,
however, give much room for market forces to deter-
mine prices, although some latitude to set prices is
granted small producers who run their own shops.
The regime boosted the farms' costs even as it offered
positive incentives. The reform imposed di/ferential
rents on farmland, which for the first time were
assessed on the basis of the land's fertility. It sharply
reduced subsidies for agricultural machinery and
fertilizer and set prices of many inputs at cost, forcing
farms to come up with their own investment re-
sources; official budget figures show that subsidy
payments fell 39.1 percent from 1983 to 1984. The
clear message was that only strong producers and
efficient users of inputs would be profitable, and the
regime would not permit customary bonuses to work-
ers or managers in subpar state farms (VEGsJ or
cooperative farms (LPGsJ.
At the same time, the regime recognized administra-
tive problems and made organizational and procedur-
al changes. It implicitly recognized that its policy of
creating extremely large farms-up to 15,000 hect-
ares-had been mistaken. The government publicly
admitted the inefficiency of trucking "cooperative
peasants"many kilometers per day to distant parts of 25X1
farms when they could work in the vicinity of their
homes. To improve the management of the farms, the
government also subdivided the LPGs, for adminis-
trative purposes, into as many as four subsections
and strengthened the operating authority of the
subunits' managers, who could better manage the
smaller plots. The reform changed performance crite-
ria to emphasize se(f=si~ficiency, net production, cost
reductions, and profits. In June 1985 the regime
moved to improve efficiency further by reuniting
previously separate and overspecialized crop and
livestock producing farms-a carryover from when
the GDR thought that extreme specialization was
beneficial-reducing the need to transport fodder
long distances from farms to feedlots.
The changes in agriculture marked major mod[fica-
tion in two longstanding SED tenets-that strong
pecuniary incentive in agriculture should take second
place to political motivation, and that agriculture can
and should be treated as a variant of large scale
industry. They reflect recognition by the regime that
the unique problems of agriculture required greater
devolution of authority and incentives at the producer
level. The organizational changes in agriculture,
however, have no rough equivalent in any other sector
of the GDR economy. Moreover, the measures did
not introduce real reform in terms oflreedom of
action of individual LPG and VEGs, real market
forces, or markedly increased scope of freedom for
private agriculture.
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The government moved to increase the effectiveness
of investment by shifting financial and supervisory
responsibility to the individual economic entities, no-
tably the combines. Combine management and em-
ployees would have a greater incentive to see that
investment resources were well used because poorly
executed projects would be unproductive, cutting the
combines' profits and the employees' bonuses. New
regulations also increased financial penalties for poor-
ly conceived projects.
The shift in responsibility for managing investment
emerges from official data on investment financing.
Funding by central authorities fell more than 6
percent in 1985 after a drop of nearly 13 percent in
1984 and a smaller decline in 1983. At the same time,
the combines are carrying out more so-called rational-
ization investments in which they draw on existing
resources to set up new or improved production
capacities. Official statistics show a 21-percent in-
crease in combine-managed investment in 1985 over
1984. While this reflects a judgment that the produc-
tion unit knows best how to utilize investment goods,
it could lead to some duplication of capacities across
combines and, more likely, ineffective construction by
technically deficient combine crews. Even though a
greater share of investments is being funded from
enterprise-retained earnings and bank credits, central
authorities continue to make basic decisions on major
projects
More Incentives for Workers
East Germany has made increasing use of material
incentives to encourage greater worker productivity.
Probably most important, the regime has generally
kept its promise that the higher wages earned by
harder work can be used to buy better quality goods.
With the exception of the lean years of 1982 and
1983, the regime has
consistently been able to deliver more and higher
quality goods to retail stores-both low-priced outlets
providing subsidized "basic" goods and Intershops
that sell luxury Western goods much prized by East
Germans.10 The government also is expanding its
10 The regime has another motive. Most of the hard currency spent
in the /ntershops are West German marks that East Germans
receive as gifts from friends and relatives in the West. The stores
have become a significant hard currency earner for East Berlin
chain of Delikat and Exquisit specialty stores that
sell luxury goods at higher prices in domestic East
German currency. By a variety of measures, East
Germans enjoy the highest level of personal consump-
tion in the Communist world.
To improve their system of incentives the East
Germans have developed a complex system of wage
differentiation. Official statistics show average
monthly earned income of 1,130 East German marks
in 1985." Education and qualifications are major
criteria for wages, with apprentices (at 100 to 200
marks per month) and unskilled labor (300 to 500
marks) at the bottom of the economic ladder. Farm
workers make 500 to 700 marks per month. Factory
workers receive 1,000 to 2,000 marks per month
before deductions of roughly 20 percent of wages,
about the same as university-trained specialists; ser-
vice workers earn somewhat less. Midlevel managers
may make up to 1,500 marks.
combine directors-general may earn up
to 3,000 marks monthly. The regime also uses piece
wages in some industries, and offers special or hazard-
ous duty pay to entice workers to unattractive jobs,
including those on joint Soviet-East German projects
in the USSR.
The government is boosting financial incentives for
high-quality work, and is making it increasingly clear
to workers that they cannot expect automatic bonuses
for substandard performance. Bonuses are periodical-
ly awarded for fulfillment of group objectives-such
as those of a labor brigade-which are paid out of
funds generated by enterprise profits. These bonuses,
vary considerably across
industry; the potentially large size of these bonuses-
perhaps as much as several months pay-are intended
to be a strong incentive to high productivity. Our
Embassy in East Berlin reports that these bonuses
" The domestic East German mark is inconvertible into Western
currency and an approximation of its value is obscured by changing
rates of exchange between the domestic and foreign trade (Valuta)
mark. East Berlin claims that its domestic currency is equivalent to
the West German mark, which in late 1986 was worth about 50
cents. However, on West German spot markets, the East German
mark is worth only about one-fifth of a West German mark.
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occasionally create friction in the work-place, with
more energetic workers chastising laggards. This sug-
gests that combine managements have heeded orders
not to automatically grant bonuses.
To encourage individuals, enterprises also offer non-
monetary awards, individual bonuses of up to several
months' wages, and special access to consumer goods
in short supply; they also impose penalties. In 1984,
for example, the regime sold a special shipment of
10,000 Soviet-made Lada automobiles to outstanding
workers nominated by their enterprises; the normal
wait for a car is over a decade. The Zwickau motor
transport enterprise in 1984 offered its truck drivers
clear incentives for efficient driving. It authorized
each a fixed amount of fuel per 100 kilometers of
travel, and, if the driver used less than his allotment,
he would receive an extra 9 pfennigs per hour worked
for every liter saved. If he used more, his pay was to
be cut at the same rate.
employee errors in the workplace can result in penal-
ties of up to several months' salary.
New Planning and Performance Criteria
East Germany, like other centrally planned econo-
mies, employs a host of "norms," "balances," and
"indicators" to ensure that materials are used in
accordance with the plan and to measure enterprise
performance against plan goals. In 1982 the regime
formulated more stringent planning norms that in-
creased the share of economic inputs controlled by the
plan and placed specific limits on the use of key
materials down to the enterprise level. At the same
time, the regime revamped the process of balancing
uses against resources to ensure the primacy of its key
economic goals and to enhance the combines' role in
material balancing. The regime focused material bal-
ancing on controlling the allocation of the most
essential energy resources and raw materials to
achieve maximum output, on using capital equipment
to support improved export performance and more
effective investment, and ensuring adequate supplies
of consumer goods.
The combines were given a greater role in this process
in order to diminish bottlenecks and improve coordi-
nation. Given the regime's objective of operating at
maximum capacity despite constraints on imports,
raw materials, and energy, the combine directors-
general needed greater authority to make and imple-
ment timely decisions on the use of inputs. In 1985 the
central authorities-the Council of Ministers and the
State Planning Commission-set the balances for
1,050 of the most essential items in the economy. The
combines, in turn, set the figures for 1,086 elements,
with the approval of the supervising ministry. Another
2,400 balances were set directly by the combines or
subordinate enterprises, subject to the approval of the
combine director-general.
The central authorities have also toyed with the
criteria used to evaluate combine and enterprise per-
formance. Success in meeting various criteria deter-
mines the allocation of money to a series of "funds"
that the enterprises use for wages, investment, and
purchases of inputs. The most successful enterprises
under these criteria have the greatest access to the
resources needed to maintain and expand operations.
These criteria also determine the amount of money
authorized for payment of bonuses to managers and
workers.
Since 1984, East Berlin has downgraded the impor-
tance of gross measures of output in evaluating
enterprise performance in favor of four criteria that
put greater emphasis on conserving inputs and on
meeting the demands of domestic and foreign
markets:
? Net profit earned by reductions in costs but not by
unauthorized price hikes or reductions in quality.
These earnings can be used for worker bonuses and
expansion of enterprise capacity with the permission
of planning authorities or retained for future use in
bank accounts.
? Net production, or output minus consumption of
materials and depreciation. This measure is intend-
ed to encourage greater efficiency in the use of raw
materials and energy.
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The regime, in recent years, has enacted new regula-
tions to improve planning in general and incorporate
industrial combines more directly into the planning
process. The Order of Planning in 1979 mandated
procedures for drq/ting the 1981-85 Five-Year Plan
while a related Basic Set of Operating Principles
established regulations for the annual plans. There-
c~ter, a series of supplementary regulations were
issued to clarify rules and procedures.
East Germany has an elaborate central planning
apparatus with the State Planning Commission (SPKJ
at its center. Headed by candidate East German
Communist Party Politburo member Gerhard
Schuerer, the SPK coordinates extensively with both
the party and the Council of Ministers. The SPK is
charged with the development of annual and five-year
economic plans (FYPsJ, and it supervises implementa-
tion of the plans; the SPK also has the major
responsibility for longer term plans such as the
CEMA science and technology initiative through the
year 2000. Many details of the planning process,
which integrates all the plans, are considered state
secrets by the GDR, and the SPK maintains a fairly
low public profile. We know, however, that the GDR
prepares elaborate, detailed plans making extensive
use of econometric models and computers.
The planning process begins early and involves nearly
all significant economic institutions, but with major
responsibility borne by the combines. Annual plan-
ning begins in thejirst half'of the year before the plan
period, while preparation for the FYPs begins two or
three years ahead.
planning begins relatively informally at the lower
levels of the economy-including the individual en-
terprise and farm-and becomes increasingly rigor-
ous. At first, the SPK asks economic institutions
what they will need, what they can produce, and how
they can reorganize processes and enterprises to
improve production, boost exports, and save materi-
als. Initial requests and objectives are modified in
light of state need, resource constraints, or belief that
enterprise goals are unrealistically high or low. ~1'ter
much discussion, industrial ministries, combines,
VEBs, and farms jznally receive explicit instructions
on production goals, and investment, personnel, and
hard currency allocations. The,final directives, issued
by the Council of Ministers, are binding and not
normally subject to appeal. Combines, ministries,
and even the Foreign Trade Bank then become instru-
ments of the plan, with roomlor initiative left to
those areas not explicitly determined by the plan.
Western observers generally rate East German eco-
nomic planning as being comparatively good, given
the inherent problems of running a centrally planned
economy (CPE). The East Germans have developed
sophisticated planning tools and have thoroughly
integrated the process into the economic life of the
country. Thorough preparation means that the major
dislocations so commonly reported in other CPEs-
massive hoarding by enterprises and "storming" at
the end of plan periods, for example-seem relatively
Production problems at individual plants can quickly
affect the output of customers, a situation caused by
comparatively low inventories, not hoarding. Al-
though East Berlin probably has improved the pro-
cess somewhat in recent years, East German of.~cials
say publicly that further gains are needed, and there
undoubtedly is room for improvement.
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~e~re~
? Products and services for the population. This mea-
sure is intended to increase domestic consumer
supplies and exports of consumer goods and requires
all combines, even those in heavy industry, to
produce consumer goods.
market prices and domestic costs. This policy is
intended to spur greater efficiency in the use of
energy and materials, because prices presumably
? Exports to meet the goal of reduced debt to the
West and the USSR and to fund needed imports,
especially from the West
With greater emphasis on net profit, enterprise man-
agers are now supposed to respond, at least in theory,
to considerations of costs and revenues rather than to
physical output quotas in determining what and how
to produce. But net profit is still less important to an
East German manager than to his counterpart in a
market economy. In part, this is because the other
indicators-production of export goods and consumer
goods, net production, and the many other less impor-
tant criteria-enter into the evaluation of East Ger-
man enterprise performance, but may not necessarily
be consistent with maximizing net profit.
Although profits may not have assumed the same
importance as in a Western economy, they seem to
have introduced some financial discipline into East
German economic management. While the govern-
ment does not allow Western-style bankruptcies
the authorities take
action to deal with chronic money-losing firms in lieu
of extending operating subsidies. The government
may extend short-term assistance to firms with tem-
porary problems by providing (high-cost) credits or, on
rare occasions, authorize wage cuts to tide over a
troubled enterprise. But if management is unable to
turn the situation around, the authorities will replace
the managers or reallocate assets to more successful
enterprises in intra-combine reorganizations. Even
marginal combines have been broken up.
Financial Levers
Consistent with the greater emphasis on profits, the
regime is making somewhat greater use of financial
levers-such as prices, taxes, and interest rates-to
influence enterprise decisionmaking. As a result of
new price formation procedures adopted in 1983,
planning authorities have been adjusting prices for
production inputs more frequently to reflect world
come closer to reflecting real economic costs.
East German authorities have also made greater use
of price differentials to spur exports and innovation.
The regime authorizes the combines higher domestic
East German prices for goods that are exported to the
West. It grants 2-percent higher prices for goods
awarded the "Q" symbolizing world-level quality and
offers higher prices for new or improved products. The
authorities, however, lower prices on goods judged to
be obsolete or of poor quality.
These more active pricing policies do not, however,
constitute a basic price reform. Prices, wages, and
foreign exchange rates remain under tight central
control. The absence of market forces in determining
prices-even some private handicraft prices are con-
trolled-means that, at best, central authorities are
only minimizing the distortions between prices and
true economic costs. Moreover, regime policies have
continued to deliberately subsidize many prices, par-
ticularly for basic consumer goods, and to undervalue
capital. Profit maximizing decisions by enterprise 25X1
managers in response to these centrally fixed prices
continue to reflect planner preferences and not neces-
sarily the most efficient allocation of resources.
25X1
The regime is making greater use of its taxing power
to encourage savings in the use of capital and labor. 25X1
On 1 January 1984, the government imposed a 70-
percent tax on the wage funds of industrial enterprises
that was designed to discourage "hoarding" of labor
and to boost productivity. In order to reduce their tax
bill and protect profits and bonuses, enterprises cut
hiring, contributing to a rise in unemployment despite
a constitutional ban on joblessness. The regime al- 25X1
lowed some transition to the steeply higher wage tax
by providing a new subsidy to enterprises in 1984, but
it forced the enterprises to shoulder more of the
burden in 1985 by cutting subsidy payments by 71.3
percent
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As part of its effort to "rationalize" investment, the
government, since 1982, has imposed a 6-percent tax
on investment not completed on time and a 12-percent
surcharge on inventories deemed excessive. The regu-
lations waived payment of asset taxes on projects
completed ahead of schedule until their originally
scheduled completion date. The government also im-
posed taxes on little-used productive assets in an effort
to boost capital utilization rates.
The authorities use the state banking system to
pressure poorly performing enterprises and to reward
good ones. The banking system has been given a
greater role, in conjunction with planning authorities,
in assessing the viability of investment projects. It
limits loans to problem firms-much like Western
banks-and, after specified intervals, imposes higher
interest rates on loans. The banks charge differential
interest rates for different kinds of projects. They
grant lower rates to profitable enterprises and to firms
producing high-quality output and goods intended for
export. The regime in recent years also has encour-
aged private enterprise by increasing the availability
of inexpensive credit, a move that we believe has
encouraged the modest recovery of that sector (see
inset on page 17).
Regulatory Changes
Although central authorities have given greater atten-
tion to financial levers, they have resorted to tighter
administrative measures to deal with certain prob-
lems. Some of these controls have come in areas
where planners judged that changing prices would not
have produced the quick response needed or would
have been highly disruptive to carefully calculated
balances. Many others fine-tuned existing procedures
and provided specific guidance in the wake of larger
decrees like the one for the combine reorganization.
The most prominent area for new regulations has
been the transportation sector. A large number of
decrees issued in the period 1982-83 were primarily
aimed at reducing liquid fuel consumption in the face
of oil shortages.12 The regime slashed monthly fuel
allocations for trucking companies, idling many at the
end of each month. Other published government
orders restricted usage of trucks and ordered greater
reliance on railroads and inland waterways for freight
transport. The result has been a major change in the
structure of transportation in the GDR.
Government economic regulations run the risk of
producing bottlenecks, evasion, and other counterpro-
ductive behavior. This undoubtedly has occurred in
some instances but, on balance, we believe these
regulations have been modestly effective.
authorities evidently have allowed few appeals, a
practice that could quickly ruin a regulation if appeals
are granted too liberally. Nonetheless, the regime
demonstrates some flexibility by repealing or amend-
ing regulations shown to be ineffective or outdated.
Stability Amidst the Change
Despite the organizational and policy changes, the
Honecker regime has left much of the fundamental
economic structure in place. The combine reorganiza-
tion has never threatened the primacy of the party
and government central planning authorities in deter-
mining macroeconomic policy, setting general goals
for combines, controlling prices, and allocating invest-
ment and hard currency. Although some power of the
industrial ministries has been devolved to combine
managers, central control may have grown even stron-
ger with the reduced authority of VEBs, increased
'Z Effective in 1982, the USSR reduced oil deliveries on soft
currency account from 19 million metric tons to 17.1 million. The
hard currency shortage prevented East Berlin from buying replace-
ment oil in the West and necessitated imposition of significant
conservation measures. Despite the severe rationing of East Ger-
man businesses, consumer supplies and prices were not aH'ected-a
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The private sector is a small but important part of
the East German economy, especially in crafts and
services; it accounted for 2.8 percent ojproduced
national income in 1985, according to official statis-
tics. According to the o.~cial news agency ADN,
some 82,000 private enterprises and 2,800 production
cooperatives-semiprivate associations ojprivate
firms-employed 420,000 people in 1985 or some,five
percent of the work force. According to official
statistics, roughly hajfojthese work as artisans,
while about 10 percent work in both the construction
and domestic trade sectors. Essentially none are in
industrial jobs.~~
Private enterprise contributes significantly in some
areas ojthe economy. According to the party newspa-
per Neues Deutschland, private firms and semiprivate
construction cooperatives in 1984 provided 70 percent
ojgeneral service and repair work done in the country
and 52 percent of housing repair. Individuals and
concessionaires ran 40 percent ojrestaurants and
taverns in 1984; by all accounts they are a welcome
improvement over state-operated restaurants. Private
.firms also carried 20 percent ojcargo hauled by truck
in 1984.1
Entrepreneurs operate under strict rules. The regime
limits the scope ojactivities and strictly controls the
size ojprivate enterprises. It sets prices at which the
private sector sells its goods and services and imposes
special taxes on private firms. The regime also
requires that entrepreneurs obtain operating licenses
before doing business-15,000 were granted in 1985,
according to the East German press-and comply
with a host ojregulations. The regime both encour-
ages and controls the private sector by providing
needed supplies at government-established prices and
offering credit from the state bank. The result is an 25X1
extremely stable stock ojprivate enterprises that are
both modestly profitable and unlikely to jail.
The private second economy works very difj"erently in
East Germany than in other East European coun-
tries. The regime encourages second jobs and encour-
ages payment in West German marks-which circu-
late as a second semiofficial currency-because it
knows that it will eventually acquire most through its 25X1
hard currency Intershop system ojretail outlets. The
government strongly discourages, however, a true
black market; econom-
ic criminals a
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e dealt with harshly.
East German Government policy on private enterprise
has shifted over the years. The Honecker regime
slapped sharp new regulations and disincentives on
the sector in the early 1970s, and the number of
workers in private small businesslell to 250,000 in
the mid-1970s, compared with 860,000 in 1950. Since
the mid-1970s the regime has modestly encouraged 25X1
private enterprise, and the sector has experienced
steady, if unspectacular, growth. Repeated public
praise by Honecker in the mid-1980s is but the most
obvious sign that the SED appreciates a modest, petit
bourgeois presence in the first "workers' and pea-
sants'state on German soil." The regime apparently
believes it can adequately control entrepreneurs and
shows no fear ojpossible development ojreactionary
economic elements
regulation of parts of the economy, and more strin-
gent planning norms and performance evaluation
criteria.)
The basic institutions of senior economic decision
making have remained the same. The major organiza-
tional casualty of the combine decree-the VVB-
had no fundamental policy role. The key actors have
remained: the Politburo, the Central Committee and
its departments on the party side; and the Council of
Ministers, State Planning Commission, and ministries
on the government side (see appendix B). The regime 25X1
maintained the status of most implementing organiza-
tions-those without independent decision making
authority-such as the Foreign Trade Bank. It has,
however, created in recent years a few new regulatory
bodies to monitor combine performance
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East Germany's Senior Economic Decision Makers
issues . .
Guenter Mittag ...chief economic policy maker in the GDR ...party secretary
for economic gfjairs since 1962 except for stint as a first deputy premier during
1973-76 ... full Politburo member since 1966 ... tough, pragmatic in approach to
Gerhard Beil ...his appointment as Minister for Foreign Trade in May 1986
rejiects growing irtfiuence and status as a longtime top foreign trade o.~cial .. .
previously responsible for trade with Western nations ...deeply involved in
efforts to improve US-GDR economic ties ...respected, irtfluential, a key player
in implementing trade policies of economic "czar" Mittag and a possible
successor to him should Mittag's health worsen ...former Nazi Party member,
joined SED in 1953 ... shrewd, aggressive negotiator ... 60.
Gerhard Schuerer ...deputy chairman, Council of Ministers, and head of the
State Planning Commission ...also has party status as a candidate member of
Politburo ... primarily a party functionary in economic management positions,
not a trained economist . .
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..spent three years at CPU ig er arty
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School in Moscow, presumably speaks Russian ...cautious, competent, knows
his subject thoroughly ... 65.
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Guenther Kleiber ...became full member of Politburo in 1984, after 17 years as
a candidate member ...deputy chairman, Council of Ministers, and Permanent
Representative to CEMA, responsible for overall GDR technological cooperation
within CEMA ...electrical engineer, experienced in machine tools, electronics,
and data processing development ...has been the GDR's top economic trouble-
shooter to the Arab world ... a protege of Mittag and close to Honecker ... SS.
Werner Fej/e ...member, SED Politburo (since 1976) and secretary for agricul-
ture (since 1981) ...party careerist with no agricultural training but extensive
experience as a party overseer ...spent 10 years as first secretary in Halle
District, the GDR's top industrial producer and polluter ...has ties to Honecker
dating back to Free German Youth work in the 1950s ...competent administra-
tor ... 58.
Werner Jarowinsky ...SED secretary responsible for domestic trade and supply
matters since 1963 ... became a full Politburo member in 1984, after 21 years as
a candidate member ...well educated, has studied and taught economics, holds a
doctorate ...his long tenure as a party secretary presumably indicates leadership
satisfaction with his job performance ... 59.
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Mittag's Meetings With the Managers
Party secretary for economics Mittag meets with the
country's party and industrial economic management
twice annually, just before the Leipzig Trade Fairs.
Managers in attendance include:
? All the combine directors-general.
? Central Committee economic department personnel.
? Party organizers.
Government representation, by contrast, is small even
though the combines are directly subordinate to the
ministries.
The 2-day seminars organized by the SED Central
Committee feature Mittag s comments on policy and
a review of economic successes and failures. The
managers compare notes on problems. Mittag,
is candid in his
remarks and has been pointedly critical of some
combine directors-general. Some of the critiques
show up in the East German press. Sessions like
these-combining the most senior SED economic
leadership short of Honecker and the significant
industrial managers in the same room-illustrate the
ease of communication of economic policy in a coun-
try oj'under 16.7 million people occupying an area
the size oj'the state of Ohio.
crisis of the early 1980s, East Germany has been the
most successful East European country in reviving
economic growth, strengthening its hard currency
financial position, improving living standards, and
reducing trade deficits with the USSR. While we
cannot prove, for methodological reasons, a direct link
between East Berlin's actions and these gains, the
correlation appears strong. Nonetheless, some mea-
sures have been counterproductive, and significant
problems and challenges remain
The Successes
Aggregate measures of economic performance show
that the East German economy rebounded strongly in
the period 1984-85 from stagnation and recession. By
East Berlin's measures, national income grew an
average of 5.2 percent over the past two years,
compared with 2.6 percent in 1982. Our calculations
of gross national product show a similar pattern of
economic recovery. After declining in 1982 to zero,
East German GNP growth in 1984-85 reached a level
somewhat above that of 1976-80.
East Germany's performance compares well with that
of the other CEMA countries. By 1985, East German
economic growth-as measured by officially reported
national income figures-was leading all CEMA
countries except Romania, whose statistics almost
certainly are much exaggerated. This comparison-
The key decision making cadre remained intact
through the changes of the last several years. Honeck-
er's economic team implemented the policies of rapid
growth and increases in consumption of the 1970s, as
well as the recent efforts designed to correct problems
caused by these policies and a more difficult external
environment. We judge that the stability of the senior
economic leadership reflects the competence of the
individuals and their consistent adherence to evolving
party objectives.
Data on economic performance
suggest that the changes
in East German economic management have general-
ly paid off. Since the region's economic and financial
combined with East German success in fostering
greater efficiency and technical innovation-presum-
ably prompted Gorbachev's praise of East German
economic management as well as East Berlin's appar-
ent self-satisfaction with its accomplishments.
Major gains in agricultural performance-following
the agricultural price reform and associated organiza-
tional changes-contributed much to the rise in East
German growth. The GDR recorded two consecutive
record grain harvests. Production reached 11.6 mil-
lion metric tons in 1985, according to East German
statistics, a sharp jump from the roughly 10-million-
ton level of the previous several years. Preliminary
figures point to another good harvest in 1986. Produc-
tion of other major agricultural goods also has risen
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Figure 3
Eastern Europe-USSR: Growth of
National Income, 1980-85
Romania
East Germany
Czechoslovakia
Although all East European economic statistics are suspect, Romanian
figures appear particularly unreliable. We believe actual growth, using
socialist accounting methods, was considerably below reported levels.
markedly. Although favorable weather, more irriga-
tion, and better farming techniques contributed to
agriculture's good performance, the US agricultural
attache in East Berlin believes the stimulus of the
price reform also helped boost output.
The recovery in industrial performance seemingly is
less impressive. After slowing to about 1 percent
growth in 1982, the increase in industrial output-
measured by Western accounting practices-has av-
eraged 2.0 percent over the past three years (see table
2 and figure 4). While still below levels of the 1970s,
this performance stacks up well against that of the
other East European countries. Only Polish industry,
which was rebounding from the depression of
1981-82, can claim somewhat better numbers. More
important, East Germany has been able to bring
industrial growth back up to levels near that of the
late 1970s despite severe cutbacks in imports from the
West, reduced oil supplies from the USSR, and
pressures to boost exports to both hard currency and
Soviet markets.~~ 25X1
Because of the need to adjust to more costly inputs
and reduced resources from East and West, the
critical measure for East German economic manage-
ment is its success in improving efficiency and produc-
tivity. East German official data and our own calcula-
tions indicate that such improvements have played a
key role in keeping industrial output and the overall
economy growing. The regime has regularly reported
reductions in costs per unit of industrial output of
about 2 percent annually in the last several years as
well as savings in the use of energy and raw materials:
? The most striking improvement has come in reduc-
ing the consumption of energy per unit of output.
We calculate that East German energy consumption
was only 1.1 percent higher in 1984 than in 1980
while GNP and industrial production were 7.0
percent and 8.4 percent higher respectively (see
figure 5). Official statistics show a marked shift in
the transportation mix; truck usage declined 31.1
percent between 1980 and 1984, while the use of
more efficient railroads and inland waterways rose
0.5 percent and 22.4 percent, respectively.
? The regime claims that labor productivity rose over
6 percent on average in 1981-85,including an 8.4
percent increase. Although our measures of com-
bined factor productivity show less improvement,
the trend has been upward over the past 2 years,
following stagnation in the late 1970s and sharp 25X1
decline in the early 1980s. Much of this gain, in our
judgment, reflects tighter management of labor and
capital. Legal travelers and emigres report that
managers reacted to the stiff labor tax by reducing
overmanning through layoffs and reduced hiring.
Enterprises also appear to be responding to the
prods of bank credit policies in order to economize
on investment and direct much of it to exports.
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Table 2
East Germany: Annual Rates of Growth by Sector of Origin
Transport and communi-
cations
Government and other
services
4.4
4.9
2.1
4.5
5.3
2.1
0.8
1.2
0.8
2.1
2.7
2.7
The GDR managed these gains even as it generated a
large net outflow of resources to foreign creditors.
Import controls and better export performance helped
generate the largest hard currency trade surpluses in
GDR history in the early 1980s, despite sharply
deteriorating terms of trade. We calculate that a $1.8
billion deficit in 1979 was replaced by a $1.5 billion
surplus in 1982. This $3.3 billion increase in net
exports was a major drain on the domestically avail-
able resources of a country whose GNP, we estimate,
was $145 billion in 1982. Reported nominal exports
rose 41 percent while imports fell 18 percent in that
period. We calculate that during 1981-84, the period
of adjustment to financial pressures, East Germany
boosted real exports to the West by 19 percent per
annum-more than any other East European coun-
try." At the same time, the GDR markedly closed its
trade gap with its largest trade partner, the USSR,
putting further pressure on the domestic economy.
"This calculation is based on other East European, particularly
Hungarian, prices. The estimate could be misleading to the extent
that East German products and prices are not exactly the same as
We believe the improvement in exports to the West
resulted in part from a combination of better quality
goods and more effective marketing. The GDR during
the early 1980s, for example, began to export micro-
electronic components on the basis of good quality
and low price. East Berlin claims that the value of
production meeting world quality standards was 109
percent higher in 1984 than in 1980 and amounted to
21 percent of production versus 13 percent in 1980.
Western businessmen generally confirm improve-
ments in the quality of export goods, although the
GDR still falls short of many Western quality stan-
dards. changes in the
foreign trade enterprises have made them more re-
sponsive to customer requests, improved service of
export goods, and facilitated communications with
production combines.
The hard currency trade surpluses led to repayment of
much of the GDR's foreign debt. We estimate that
the GDR's net hard currency debt fell from $12.3
billion in 1981 to about $6.8 billion at yearend 1985.
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Figure 4
East Germany: GNP by
Sector of Origin, 1984
Other material sectors 1.8 -
Communal/ other services 3.3
Forestry I.0
Construction 4.9 -
Transport/
communication 7.2
Agriculture 13.5
Industry 44.6 -
In addition, East German assets at Western banks
reporting to the Bank for International Settlements
reached $6.5 billion at yearend 1985, by far the
highest reserves among East European countries. As a
result, the Western banking community again was
eager to lend; East Berlin regularly declined loan
offers and managed to secure more favorable terms on
some existing credits
East German statistics, Western trade data, and our
calculations all point to a balanced recovery from the
financial crisis of 1982-83 and a restoration of steady
growth unique in Eastern Europe. East Berlin has
managed to adjust its economy to internal resource
constraints and external trade pressures and is again
pursuing the main economic tasks of the 1970s-
steady growth and rising personal consumption. Our
estimates show that, after stagnating in the early
1980s, personal consumption is again rising at rates
equal to or above those of the late 1970s.
Figure 5
East Germany: GNP Produced per
Unit of Energy, 1970-84
I I I I~ I I I I~ I I I I
84
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3~~222,2.~ 25X1
Perhaps most important for East Germany's economic
future, the country has continued to improve its
technical base. Although knowledgeable Western ob-
servers still rate many East German products as being
several years behind comparable Western goods,
GDR goods remain, in many instances, technological
leaders within CEMA, and some high-tech goods are
very competitive in the West. We believe the East 25X1
Germans are particularly advanced in optics, micro-
electronics, machine tools, and industrial robotics. On
the downside, however, the Soviets, in addition to
praising the East German economy, made clear in the
1986-90 USSR-GDR trade protocol that they want
more of East Germany's technologically advanced
industrial output
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We believe that a number of important human vari-
ables have helped make the organizational changes
effective in East Germany. The regime has sought in
recent years to use its human resources more effec-
tively by boosting its already considerable labor
skills-the product of a strong basic educational
system and an industrial tradition. O.~icial statistics
show continued growth in the number of university
and technical school graduates employed in economic
institutions; in industry, for example, the number of
such graduates totaled 135.8 per thousand workers in
1984, up from 119.7 per thousand in 1980. The
number of workers receiving some form of training
(including apprenticeships) rose about 2 percent annu-
ally in the early 1980s (in a roughly constant labor
force) and has reached about 85 percent of workers.
The regime also has an active training/retraining
program for workers displaced by structural change.
The result is that the quality of labor is widely
regarded in both East and West as fairly good,
complaints about
East Germany's senior economic managers appear to
be highly capable individuals. The senior hail dozen
economic decision makers within the party and gov-
ernment are well schooled, with a broad range of
experience they
generally act decisively and are able to communicate
decisions quickly via both party and government
command channels. While well irE1ormed on the
details of the economy,
they generally seem to avoid meddling
in day-today operations, leaving those to combine
and enterprise managers
The combine directors-general generally seem to im-
press Western observers as competent industrial man-
agers. They typically are fairly young by Western
business standards, well educated, and have reputa-
tions as tough administrators who sometimes rule
their combines as minif~efdoms. Some also have high
party rank, including a few with SED Central Com-
mittee membership, which helps foster combine inter-
ests and facilitates planning and communication
within party channels.
The high caliber of the economic leadership appears
to be at least partly the result of a growing economic
meritocracy. Although the party demands compliance
with basic political norms, promotions in the econom-
ic,field appear to be made mainly on the basis of
ability; some combine directors-general reportedly
are not SED members. The growing incentives, more-
over, apparently are increasing the competition
among younger managers for promotion
The party shows little tolerance for incompetence or
corruption. Mittag, has
pointedly criticized in ivi ua s at its semiannua
meetings with all directors-general. The party news-
paper Neues Deutschland has also been more critical
of the performance of specific combines in recent
years, increasing pressure for improvement
in 1982, Minister for
Agriculture Buhrig was,fired for poor performance
and Minister for Electronics and Electrical Engineer-
ing Steger was dismissed for failure to boost exports.
More recently the party, in May 1986, discovered
that o.~cials in charge of construction of the new
ferry port of Mukran had failed to complete some
work on schedule and rescinded honors granted them
only a month earlier. The party has vigorously
routed out corruption in other cases.
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The Shortcomings
The macroeconomic statistics show marked improve-
ment, but not all of East Berlin's actions have been
successful; some may have even been counterproduc-
tive. Despite its leading position in CEMA, the East
German economy still lags well behind advanced
Western industrial countries in efficiency and innova-
tion. Some of the fundamental elements of the East
German management system could preclude a nar-
rowing of that gap.
Some policies tend to inhibit initiative. The loss of
power of VEB management to the combine director-
general probably reduces somewhat the incentive and
authority for enterprise managers to introduce inno-
vations and promote greater operating efficiency. The
large combine bureaucracies probably tend to limit
risktaking despite official, high-level encouragement
of initiative. Moreover, the combines' tight rein on
scientific organizations limits their freedom to con-
duct the basic research that is needed for technologi-
cal breakthroughs. In addition, some knowledgeable
Westerners argue that financial incentives for firms
are too focused on the negative and fail to adequately
encourage combine and enterprise risk taking. Con-
tinued tight central control of investment limits enter-
prise managements' freedom to use profits, further
inhibiting entrepreneurial behavior.
Some actions have impeded East Berlin's quest for
economic efficiency. The regulatory emphasis on pro-
duction of consumer goods and the requirement that
all combines manufacture such items, no matter what
their specialities, means that some producers are
likely to be inefficient; the inefficiencies could grow as
the emphasis on consumer goods continues. The re-
duced investment of recent years that was forced by
financial stringency, even though accompanied by
efforts to boost its effectiveness, may have long-term
deleterious effects on industrial efficiency and inter-
national competitiveness. Tax regulations on capital
assets, in conjunction with reduced investment, are
encouraging extended use of old capital goods that
often are inefficient and large consumers of mainte-
nance services-a standard Communist problem. In
many cases, the GDR probably would be better
advised to scrap the machinery
The size of the combines and their dominant roles in
industry can cause problems and probably have gener-
ated some. Ministerial control of industry may suffer
from the monopoly status of combines. Ministers
could be loathe to make desirable changes that would
disrupt the operations of sole producers of key outputs
in the short run and that also could affect prospects
for ministry-level plan fulfillment. The large size of
combines and near absence of small- to medium-size
independent enterprises may limit the economy's flex-
ibility in responding to changing conditions, particu-
larly in Western markets. Improved FTE perfor-
mance probably has only partially offset this
tendency.
Finally, the plethora of changes in recent years-
reorganizations, altered supplier links, regulations,
shifts in performance criteria, for example-has cre-
ated adjustment problems in planning and operations,
which some Western observers believe have been only
partly resolved. They should tend to diminish, howev-
er, with time.
East German leaders' public comments)
suggest strongly that East Berlin will
continue the "economic strategy of the 1980s" and
that no major changes in economic management are
in the offing. Honecker said explicitly in June 1985
that the economy is no place for "experiments," and
the 11th SED Congress in April 1986 reconfirmed the
existing course. The five-year plan directive released
at the Congress projects a steady economic course
with most macroeconomic goals in line with those of 25X1
1984-85 and offers no significant new initiatives (see
table 3).
Knowledgeable West Berlin observers of the GDR
economy have told the US Embassy in East Berlin
that they expect no major changes in economic direc-
tion before the 12th SED Congress in 1991.
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Table 3
East Germany: Economic Goals for 1986-90
Investment per year (billion East German marks)
Grain production per year (million metric tons)
New or reconstructed housing units per year (units)
a Plan and actual performance data are not exactly comparable
because historical data exaggerate real economic growth by includ-
ing inflation and some double-counting. Plans, by contrast, do not
purposely incorporate such biases.
b We tentatively estimate GNP and industrial production growth in
1985 using Western accounting practices to have been 2.4 percent
and 2.2 percent, respectively. Western accounts usually yield lower
growth rates because they remove distortions of turnover taxes in
prices and include such "nonproductive" sectors as housing and
government, which generally grow more slowly than industrial
output.
Soviet Pressure for "Reform"?
We believe that the East Germans feel little pressure
to make changes in their economic system in response
to Gorbachev's calls for "radical reform" of the Soviet
economy. The East German leadership seems to be
basking in Gorbachev's praise of the combine system
and the economy's apparently good results. East
German officials have told the US Embassy and West
Berlin economists that they have studied other social-
ist "models," including the Hungarian, and found
them wanting. Nonetheless, East Berlin has to be
wary of antagonizing Moscow by gloating over its
Percent annual growth
(except where noted)
Serious Challenges Remain
Despite the comparative successes of recent years,
East Berlin has not solved basic problems that could
slow economic growth in the future. The USSR is
demanding more high-quality goods, resource con-
straints remain, and East German industry remains
inefficient by Western standards. In our judgment,
the East Germans have already wrung out most of the
easily attainable gains from organizational and policy
change. The regime increasingly will have to find new
ways to generate needed productivity improvements.
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To continue posting improvements, the East Germans
face decisions that cut to the heart of a centrally
planned economy. Reform of the pricing system is
probably the important challenge confronting eco-
nomic policymakers. Failure to set prices at their
economic cost continues to distort decisionmaking and
leads to the misallocation of resources.
The most readily observable pricing distortion in-
volves retail prices. The Honecker regime, as part of
its consumer policy, has subsidized "basic" goods and
services so that their prices have remained at the
levels of the 1930s. This has mollified consumers, but
by artificially boosting some consumer demand, it
risks draining away increasingly valuable resources
from industrial investment. This distortion has grown
dramatically since the 1984 increase in procurement
prices of farm products. According to official statis-
tics, subsidies rose 140.9 percent from the period 1980
to 1985 to 40.6 billion marks~ver 17 percent of both
the state budget and produced national income. While
less evident in budgetary terms, the lack of a mecha-
nism to measure the true costs of capital, labor, and
industrial inputs is an even greater hindrance to
overall efficiency. Without accurate measures of costs
and benefits, planners cannot reliably determine the
best use for constrained resources.
A number of East German economists have called for
an overhaul of the economy's pricing mechanism.
Indeed, beginning this year, the regime launched a
revaluation of chronically undervalued capital assets
that has resulted in increased capital costs and higher
prices for output. The intention is that higher real
costs will induce combines to use their plant and
equipment more efficiently. In our judgment, howev-
er, amore thoroughgoing effort at price reform-akin
to Hungary's intent to link producer and consumer
prices to world market levels-is highly unlikely. The
Honecker regime's commitment to low, stable prices
of basic consumer goods appears unshakable. More
important, the regime is unlikely to alter its adminis-
tration of industrial prices because of its ideological
aversion to surrendering control of economic activity
to market forces and the ensuing complications to
planning and coordination.
Modernization and Restructuring
The regime must also increase outlays for investment,
particularly if its program for promoting scientific
and technological progress is to succeed. The Hon-
ecker regime has long touted improvements in science
and technology as a motor for economic growth, but
its importance in East Berlin's economic strategy
appears to be increasing. Domestic resource con-
straints and toughening international competition
have apparently convinced East Berlin that more
rapid gains in technological development are essential.
Soviet emphasis on modernization, including the
CEMA science and technology program through the
year 2000, have added impetus. In response to these
pressures, the regime in 1985 announced a new five- 25X1
year plan for scientific and technological develop-
ment; it has not, however, released details.
If this initiative is to be more than rhetoric, the
economy must receive more investment, much of it
high-tech capital goods from the West, to make up for
the reductions of recent years and to modernize key
industrial sectors. East Germany's much improved
financial position has still not weakened the regime's
caution about increasing investment and imports from
the West. East Berlin must decide what and how
much it can afford to buy, while maintaining the hard
currency trade surpluses and ample reserves it feels,
according to foreign trade officials, are needed to
protect against another liquidity crisis.
chemicals, microelectronics,
energy, mac me ui ing, and pollution control will
receive priority. Shares were not reported in the
SED's 1986-90 economic directive, however, and de-
cisions about the allocation of investment will be
crucial to East Germany's effort to keep pace with
international technological development.
Apart from the level of funding, East Germany must
also address organizational impediments to research
and development. The regime's answer seems to be
still tighter links between combine R&D units, the
research institutes of the Academy of Sciences, and
the universities. The regime is trying to foster these
links by allocating a greater share of science and
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technology funds to combine management and then
letting the combines fund directly research and devel-
opment in academic institutes. The regime argues
that direct funding by combines and contractual
arrangements will improve communication between
the researcher and end user of new technology. It will
also strengthen accountability, because combine man-
agers will more diligently monitor S&T spending if
their funds-and profits and bonuses-are directly at
stake. A possible risk, however, is that East Berlin will
limit still further the freedom of scientists to do basic
research in favor of undertakings with clear, but
short-term economic payoffs. In our judgment, this
strategy could weaken East German scientific capa-
bilities over the long term and reduce the scientific
community's contribution to the economy.
Given the challenges and uncertainties facing East
Germany, many Western observers question whether
East Berlin's economic goals for 1986-90 are achiev-
able. In an absolute sense, this skepticism is valid.
Shortages of the most desired consumer goods will
remain, product quality will remain inferior to West-
ern standards in many areas, and the East German
economy will be hard pressed to keep pace with the
technological developments of the most advanced
Western countries. Moreover, the conditions under
which the economy operates could worsen:
? Renewed deterioration in the East-West trade and
financial climate could again constrict East Berlin's
access to needed Western imports.
? Severe economic deterioration in the USSR could
lead Moscow to impose even stiffer demands, drain-
ing resources needed for consumption and invest-
ment and orienting East German technological ca-
pabilities even more to Soviet needs.
? Uncertainties resulting from an eventual succession
to Honecker could complicate economic manage-
ments
Nevertheless, we judge that a severe deterioration in
East Germany's economic environment is unlikely.
East Berlin's hard currency financial position is much
more secure than 5 years ago, and its options for
exploiting East-West economic ties consequently
the Soviets presumably recognize
that excessive pressures risk political instability in
their key East European ally and a diminished eco-
nomic contribution to their development strategy for
CEMA. Finally, a new East German leader seems
unlikely to make major changes in economic manage-
ment. Although a new SED general secretary could
redirect policy just as Honecker did after Ulbricht, we
have no evidence of major differences over economic
policy in the leadership. In contrast to the latter years
of Ulbricht's rule, the possible successors to Honecker
seem generally satisified with economic management
and performance.
On balance, therefore, we judge that the East German
economy will remain strong, by East European stan-
dards. East Germany's economic performance in the
first half of the 1980s indicates that East Berlin has
forged managerial institutions and skills capable of
coping with changing and difficult circumstances.
East Berlin's technological superiority within CEMA
and its new initiatives should ensure that scientific
and technological developments will prove a stronger
economic motor than similar efforts in other Bloc
countries. The East Germans seemingly have been
more successful than the other CEMA countries in
streamlining the centrally planned system and adapt-
ing it to the demands for more "intensive" growth.
Not only has East Berlin generated economic growth,
but it has been able to do so through cost reductions,
productivity gains, and scientific and technological
progress. Although forecasting growth rates is subject
to many pitfalls, we judge that real GNP growth may
average about 2 percent annually in 1986-90 barring
a serious deterioration in external conditions. This
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would be in line with recent performance and suffi-
cient to maintain the GDR as a major economic
power in CEMA and to support its role in the Warsaw
Pact.
The series of East German actions in recent years
may offer some ways of improving other socialist
economies, but we believe they represent more of an
example of how a socialist economy can be improved
without market-oriented reforms rather than a "mo-
del" for others to emulate. The main reasons lie in the
difficulty of transferring to other societies culture-
specific institutions and methods designed to address
specific problems.
East Berlin's actions have evolved piecemeal to cor-
rect East German problems within the context of a
small economy composed of well-educated, reasonably
well-disciplined workers, and experienced managers.
The policies were designed to improve perceived
weaknesses in industry, energy, investments, foreign
trade, and agriculture within the basic operating
procedures of this corporate culture. We believe that
identical measures tried elsewhere in CEMA would
be less successful and that only some aspects-the
reorganization of foreign trade enterprises and the
agricultural price reform, for example-could be
readily transplanted.
The Soviet Union-by far the most enthusiastic ad-
mirer of East German economic management within
CEMA-has concentrated its praise of the GDR on
the changes in industry but as yet has emulated little.
We believe Moscow is particularly attracted by im-
proved efficiency in the use of energy and raw
materials, continued tight central control, and mini-
mization of the political risks that real decentralizing
reform could entail-a concern apparent in Soviet
attitudes toward reforms in Hungary and China. Yet
some Soviet economists have expressed skepticism
that East Germans methods can be successfully bor-
rowed. Most of the pessimism has focused on the
perceived lower levels of skill, dedication, and initia-
tive of the individual Soviet worker and manager
compared with their GDR counterparts. We suspect
that the Soviets might eventually adapt aspects of
East German practice as part of a "smorgasbord"
approach to reform-selective borrowing of practices
from other socialist states modified by Soviet condi-
tions, needs, and experience.
Continued improvements in the efficiency of the East
German economy will keep East Germany an eco-
nomic power in CEMA and help East Berlin support
Moscow's domestic economic programs. It should-
despite recent friction over bilateral trade relations-
keep the GDR the largest trading partner of the
Soviet Union and maintain East Germany's position
as a technological leader within CEMA. Improvement
in export competitiveness, despite recent losses from
the decline in oil prices, probably will keep East Berlin
in hard currency trade surplus and keep the GDR a
favorite of Western bankers. Finally, a continued
example of East German prosperity could help spur
other East European regimes to redress clear econom-
ic ills, further contributing to the strength of CEMA
and the power of the Warsaw Pact
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Figure 6
East Germany: Government Party
Economic Decision Links
- Formal command
- De facto command
- Communications
Foreign
Trade Bank
~~
Other
Ministries
Ministry of
Finance
Domestic Banks
Ministry for
Foreign Trade
State Planning
Commission
Industrial
Ministries
~_
VEBs
This diagram shows lines of formal institutional command, de facto
command. and communications between the industrial combines, key
government bodies, and SED organs.
SED Central
Committee
District (Bezirk)
SED Organs
County (Kreis)
SED Organs
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Appendix B
Party/Government Economic
Management Links
ernment positions.
The Sozialistische Einheitspartei Deutschlands
(SED) and the government play major and often
overlapping roles in East German economic manage-
ment. Each issues directives and receives feedback
through its channels. Complaints about each are
conveyed through the other. In addition, many senior
economic decision makers hold both party and gov-
Schuerer is a candidate member.
The party clearly retains ultimate power over econom-
ic management, as it does over the entire GDR. The
Politburo of the SED Central Committee is the
primary decisionmaking body, deciding major policy
questions and, in some cases, micromanaging the
economy. The chief economic policymaker on the
Politburo is Party Secretary for Economics Guenter
Mittag; although but one of 22 members, he appar-
ently is given comparatively free rein by his col-
leagues. Other economic figures on the Politburo are
Werner Jarowinsky, Party Secretary for Trade and
Supply; Werner Felfe, Party Secretary for Agricul-
ture; and Guenther Kleiber, formerly an industrial
minister and now the GDR representative to CEMA.
State Planning Commission Chairman Gerhard
all levels of the government economic hierarchy.
and through them, the factories and farms. Mittag,
who holds government rank only as a deputy chair-
man of the Council of State, sometimes intervenes at
Politburo members direct the actions of the Council of
Ministers, the highest government body; Chairman of
the Council of Ministers Willi Stoph also is a Politbu-
ro member. The Council of Ministers, in turn, super-
vises the State Planning Commission, the ministries,
If a problem is serious or the importance of a project
great, a Politburo member personally supervises the
issue. In early 1982, for example, Politburo member
Horst Dohlus directed the repair of a coal gasification
unit at Schwarze Pumpe, which had been destroyed
by an explosion, and had threatened the entire domes-
tic gas distribution system. Politburo members regu-
larly check on the progress of "national defense"
projects.
The senior party leadership also operates through
economic departments of the Central Committee and
the districts (Bezirke). A department watches each 25X1
government ministry, its actions, and the activities of
its subordinate organizations, and communicates reg-
ularly with its charges at all levels. The district party
organizations have sections that follow the activities
of the economic entities operating within their bor-
ders. The district party organizations touch base
regularly with the party organs within combines and
Yolkseigene Betriebe (VEBs); the Politburo uses these
policy issues with combine directors-general to ensure
that operations are in accordance with SED policy
and are in the interests of the workers and the district.
County (Kreis) parties are too small to exercise signifi-
cant continuing supervision over combines that spread
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weigh in on more local issues, like plant working
The party organizations within combines are minor
economic decision making bodies. They apparently do
not contribute to policymaking or overall operational
management. Instead, they concentrate on party or-
ganizational matters and ensurance of worker rights,
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such as safety and the adequacy of combine-provided
worker housing. During the austerity period of
1982-83, for example, the local party apparatuses
(Bezirk and below) actively sought to ameliorate
discontent over shortages in factory canteens by
quickly promising improvements and requisitioning
supplies. In these ways, the party performs some of
the functions that otherwise might be handled by the
toothless official labor union (Freier Deutscher
Gewerks chrdtsbun~ (FDGB). Combine party organs
apparently complain to district party authorities
about combine management only occasionally, and
then over comparatively minor issues.
Communication up the chain seems confused organi-
zationally, but apparently is fast and reasonably
efficient. Combines and enterprises often use both
government and party channels to complain about
problems, and the party often intervenes to correct
ministerial problems. For example, combine manage-
ments complain to the party when failure of another
combine to provide needed parts threatens interrup-
tions in production. Party authorities typically act
quickly~ommunication from bottom to top may
take a few hours-to uncover the cause of a problem
and correct it, apparently with only perfunctory coor-
dination with industrial ministries. Similarly, though
apparently to a lesser extent, economic managers
complain through government channels when local
party officials become too heavyhanded. Party and
government bodies collaborate in, for example, inves-
tigating falsification of enterprise performance reports
or crimes such as embezzlement.
The distinction between party and government au-
thority is blurred further in practice by the dual roles
that many officials play. Final decisions on major
economic policies, made by the party, are in fact
influenced by all aspects of economic management
because many senior government officials-including
combine directors-general and industrial ministers-
hold senior party positions, including seats on the
Central Committee. Combine directors-general often
use their party positions to help procure more re-
sources for their combines, according to East German
contacts of the US Embassy; these officials saw this
practice as a way for successful directors-general to
acquire means to increase further their successes.
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