Reforms in the East Will Help West

It is still too early to predict all the ramifications for the world economy of the rapid changes in Eastern Europe because so much will depend upon these nations’ ability to implement difficult economic reforms over the longer term. However, these historic events have already had a major impact upon Western financial markets and should help the West in other ways as well.

Perhaps the most noticeable effect has been the emergence of the West German mark as the world’s most sought after currency. Fueled by perceptions in the foreign exchange markets that the political and economic changes occurring in Eastern Europe will not only benefit the West German economy but could also result in even higher West German interest rates, the mark has risen significantly against the U.S. dollar, the British pound and the Japanese yen since the crumbling of the Berlin Wall on Nov. 9.

The driving force behind the mark’s rapid appreciation has been traders’ beliefs that West Germany’s strong links with Eastern Europe and the influx of immigrants from East Germany will spur economic growth in West Germany. The anticipated increase in consumer spending, employment, construction and investment is expected to keep West Germany’s rate of real gross domestic product (GDP) expansion above 3% this year, following last year’s 4%-plus clip. Indeed, West Germany’s economic ministry has said real GDP could be boosted by an extra 0.5 percentage point in 1990, solely because of the effects of the 700,000 East German and East European immigrants who entered the country in 1989.

What’s more, the possible inflationary impact of the increase in domestic demand is expected to encourage the Bundesbank to keep a tight grip on monetary policy. At the same time, West Germany’s fiscal policy will be more expansionary this year, because of the $14 billion in tax cuts that went into effect this month. This combination of a tight monetary policy and a loose fiscal policy will keep the mark strong. It was the recipe for the dollar’s ascent in the early 1980s.

While West Germany will be the major beneficiary of today’s developments in Eastern Europe, given the special relationship that it has with these countries, other Western European nations will also gain from the Eastern Bloc’s political and economic opening. For one thing, it will strengthen the ties among the 12-nation European Community, helping to make it a more viable and competitive economic bloc. Both West German Chancellor Helmut Kohl and French President Francois Mitterrand have emphasized that closer ties with Eastern Europe in general and progress toward German unification in particular can only take place within the framework of a united Western Europe.

To emphasize this point, moves toward monetary union were accelerated last month when the EC leaders agreed at their summit meeting in Strasbourg, France, to begin an intergovernmental congress in December that would revise the EC’s founding treaty to accommodate the final stages of monetary union. What is more, to reconfirm France’s commitment to a unified Western Europe, President Mitterrand agreed to abolish French exchange controls this month, six months ahead of schedule.

For another, some of the increase in consumer spending in West Germany that will result from the influx of East German immigrants should spill over into imports. This will help to reduce West Germany’s huge trade surpluses with the rest of the EC. What’s more, buoyant economic growth in West Germany will be extremely important to the performance of the world economy this year because it comes when a marked slowdown in economic expansion is anticipated from three of the Group of Seven nations--the United States, United Kingdom and Canada.

A driving force behind the current global economic expansion has been the sharp increase in world trade. Political and economic reforms initiated in Eastern Europe point to further opportunities this year. In particular, the anticipated restructuring of the Eastern Bloc economies will require substantial inflows of capital goods that will have to be supplied by countries outside the region, thereby giving a new spark to world trade.

The Western allies are relaxing controls on the transfer of high-technology products to the Eastern European countries that are implementing democratic and free-market reforms. This could mean hundreds of billions of dollars in orders for the information technology sector in Western Europe, the United States and Japan. Probably more than any other industry, computer and telecommunications companies in the West will be poised to benefit from the reforms in the East as their products will be critical to the modernization of the Eastern European economies. Over the next 10 years, Eastern Europe is expected to spend more than $130 billion on telecommunications alone.

A major problem that will confront Western investors, however, is that countries in Eastern Europe lack the hard currency necessary to pay for these products. Tourism could be a potential source. While foreign travel to Eastern Europe and the Soviet Union has surged in recent months, most Eastern Bloc countries don’t have nearly enough hotels to meet the demand. In response, several major hotel chains are building new hotels in Warsaw, Budapest, Prague and Moscow. But, according to many travel agents, even these projects won’t be enough.

While the United States may not stand to reap as many trade and investment benefits as some of the better-positioned countries in Western Europe, the ongoing reforms in Eastern Europe are not without some pluses. Perhaps the most significant advantage is that the end of the Cold War will bring to this country the opportunity to use the huge savings from lower defense spending to reduce Washington’s budget deficit. This, in turn, could mean lower interest rates, greater investment and stronger growth in the United States in the 1990s--important benefits in their own rights.