VoxEU Column Industrial organisation

Industrial policy lessons from East Germany’s privatisation

5 Jun 2025

There has been renewed interest in industrial policy as a tool to reshape the structure of economic activity, but little evidence exists on the successful design and implementation of these policies. This column examines the transformation of East Germany’s state-controlled economy after the collapse of socialism and draws valuable lessons from the experience for contemporary industrial policy debates. First, establishing functioning market structures may require substantial public investment as a foundation for private sector success. Second, privatisation or industrial restructuring programmes might benefit from clear, productivity-focused criteria when determining governmental support for individual firms. Third, careful consideration of investor characteristics is crucial.

Authors

Moritz Hennicke

Moritz Lubczyk

Lukas Mergele

Policymakers and researchers alike have renewed their interest in industrial policy as a tool to reshape the structure of economic activity (Juhász et al. 2024, Millot, V and L Rawdanowicz 2024). While economists have long studied whether governments should engage in industrial policy, little evidence exists on the successful design and implementation of these policies. In a recent paper (Mergele et al. 2025), we study how industrial policy can be implemented in a unique historical case study: the transformation of East Germany’s state-controlled economy after the collapse of socialism.

Following the fall of the Berlin Wall in 1989, the German government created a public sector agency, the Treuhandanstalt (Treuhand), tasked with transforming East Germany’s socialist command economy. To do so, the Treuhand was asked to decide which firms to close down, which firms to promote, and which investors to sell them to. Within five years, the agency transformed a fully state-run economy into a private market-based model – an unprecedented undertaking. In total, the Treuhand handled more than 8,000 companies, of which 60% have been sold and converted to private businesses and 30% have been pushed into liquidation. The remainder primarily constitutes firms restituted to former owners. This process provides unique insights into the challenges and outcomes associated with large-scale economic structural reform. Drawing on newly assembled firm-level data, we explore the Treuhand’s performance in the identification and promotion of productive firms and examine the long-term consequences of privatisation on firm survival, employment, and ownership distribution.

Privatisation goals and productivity-based selection

The Treuhand was established with a clear mandate: privatise as many viable firms as possible and swiftly close non-competitive ones. Policymakers believed that the selection of firms based on productivity would foster a competitive private sector that would drive long-term economic growth and secure employment. Yet, separating viable firms from those without prospects presented a substantial challenge. Our study examines how the Treuhand met this challenge and prioritised firms in its privatisation decisions.

Using extensive firm-level records – which include administrative data, privatisation contracts, and productivity measures – we document how the Treuhand effectively targeted productive firms for privatisation. Firms demonstrating higher baseline productivity were more likely to be privatised rather than liquidated. Moreover, productive firms were privatised more quickly, thus reducing uncertainty for the firms involved.

Figure 1 Privatisation, time to privatisation, and baseline productivity

Note: Left panel shows mean privatisation shares by firms’ percentile rank in the labour productivity distribution (N=6,190). Right panel depicts mean time to privatisation by firms’ percentile rank in the labor productivity distribution (N=4,076). This panel excludes liquidated firms. Rank coeffi cients are calculated using Hazen’s rule
Sources: BvS Firm Register and THA Firm Surveys.

Internal ratings and privatisation decisions

Could these findings simply reflect higher investor demand for the most attractive targets? To address this question, we study the Treuhand’s central steering committee (Leitungsausschuss), which assigned internal ratings to the most important East German firms in an effort to systematically assess firm viability. These ratings aimed to capture firms’ restructuring potential and competitiveness and served as a guide for privatisation versus liquidation decisions. In our empirical analysis, we find a clear correlation between higher internal rating scores and improved privatisation outcomes. Firms rated as more viable by the Leitungsausschuss were substantially more likely to be privatised, and were privatised more quickly, which indicates that the Treuhand played an active role in identifying firms with stronger economic prospects.

Better firms, better deals

The Treuhand’s privatisation strategy notably differed from many other countries' experiences by avoiding voucher schemes or large-scale auctions. Instead, it engaged directly with investors and negotiated both sales prices and explicit investor commitments on future employment levels and investment expenditures. This approach allowed the agency to pursue economic and social outcomes beyond immediate revenue from privatisation. Our data reveal that firms with higher initial productivity achieved better privatisation conditions. Firms that exhibited higher productivity levels attracted higher sales prices and also secured more substantial employment and investment guarantees from their new owners.

Ownership dynamics and regional wealth disparities

A central issue in East Germany’s economic transformation was the geographical origin of investors, which had direct implications for the distribution of wealth. Our analysis indicates that West German investors predominantly acquired the most productive East German firms, which tended to be larger and economically stronger. In contrast, less productive, smaller firms were more frequently acquired by East German buyers. This ownership pattern reinforced pre-existing regional wealth disparities stemming from the failed socialist experiment in East Germany and contributed to the persistent wealth gap between East and West Germany.

West German investors likely benefited from greater access to financial resources, established market knowledge, and superior management practices. These advantages plausibly allowed them to bid more successfully for valuable firms. Our findings illustrate the crucial role investor selection criteria play in shaping long-term economic equality and regional development. The Treuhand was aware of these tensions: while the agency tried to preserve the ‘East German identity’ of target firms, its focus on productivity required the inflow of capital and management expertise from the West.

Figure 2 Majority ultimate ownership distribution of privatised firms in 1995

Note: Shares of privatized firms with a majority of ultimate owners from East Germany/West Germany/Outside of Germany in 1995. Unweighted, weighted by initial revenue, and weighted by intial employment. N = 2,566.
Sources: BvS Firm Register and MUP Firm Register.

Long-term firm survival and employment after privatisation

Firm longevity is a critical measure of privatisation success. We analyse firms’ survival rates over the two decades after privatisation and find that initial productivity strongly predicted long-term viability. Firms with higher initial productivity exhibited higher survival probabilities and employment retention.

Furthermore, ownership mattered: West German-owned firms demonstrated better survival rates over the long term. Superior management practices, better capital access, and integration into established business networks may have contributed to improved economic performance after privatisation. This result reinforces the importance of buyer selection processes and institutional environments for successful policy implementation.

Figure 3 Firm success by initial productivity (privatised firms)

Note: Left: Survival rates calculated as the percentage of firms still active 5, 10, 15, and 20 years after the dissolution of the Treuhandanstalt. Right: Current employment as share of initial employment, measured 5, 10, 15 and 20 years after the dissolution of the Treuhandanstalt. Non-survivors’ employment is coded to zero for all years following their exit from the market. Rank coefficients calculated using Hazen’s rule. N = 2,566.
Sources: BvS Firm Register, Treuhand Firm Surveys, and MUP Firm Register.

The Treuhand’s legacy and policy lessons

The Treuhand's productivity-based approach successfully identified viable firms, but its operations still incurred substantial financial losses. By the conclusion of its activities, the cumulative fiscal cost reached approximately 256 billion Deutsche mark, absorbed by the German federal government. Many East German businesses received large amounts of subsidies and required substantial investment after decades under central planning. The rapid introduction of market competition and currency union created challenging economic conditions that depressed valuations of East German firms. The Treuhand took on significant debt from East German enterprises before privatisation to make them more attractive to investors. For non-viable firms, the Treuhand absorbed the cost of their closure.

The East German privatisation experience provides valuable lessons for contemporary industrial policy debates. First, the Treuhand's balance sheet illustrates that establishing functioning market structures may require substantial public investment as a foundation for private sector success. Second, privatisation or industrial restructuring programmes might benefit from clear, productivity-focused criteria when determining governmental support for individual firms. Third, careful consideration of investor characteristics is crucial, as ownership allocation significantly influences firm performance and regional wealth distributions in the long run. As governments again embrace active industrial policy, East Germany's experience offers a valuable roadmap of both successful strategies and potential pitfalls.