Restitution or Compensation for Expropriated Property?

One of the main problems of privatization was and still is restitution. According to the Einigungsvertrag, everybody who was expropriated between 1933-1945 and after 1949 had the right to restitution. The time between the end of the Second World War and the creation of the GDR was exempted from restitution claims, which was agreed to during the unification-negotiations between the Federal Republic of Germany, the Soviet Union and the GDR delegation. The expropriations of the Soviet occupying power covered 10,000 enterprises, which represented at the foundation of the GDR, 70 percent of the entire GDR industry. The Soviet Union, as the U.S.A. and Great Britain in West Germany, had carried out in East Germany a land reform to destroy the structure of large-scale land-holdings, and, especially, to expropriate persons who belonged to the Nazi regime. The time period between 1933 and 1945 was afterwards included to the Einigungsvertrag on request of the U.S.A. in order to do justice to Jewish people who had lost their property during the Nazi-regime. The Federal Republic of Germany considered to be the sole legal state on German Soil. It was therefore taken for granted to undo the expropriation of the communist regime of the GDR. From the legal point of view it seemed to be logical to return property to the former owners, and a large majority of the German Parliament voted in favor for restitution. At the time the possibility of compensation was associated with a high financial burden.

In practice, the allocation of property titles proved to be extremely difficult. Since 1933 the industrial structure of East Germany was subject to important modifications and changes, it was very difficult to relate former property to the actual enterprise or parts of it, and, it was also difficult to distinguish between ownership of an enterprise and ownership of land. Secondly, land registers and title records were neglected during the GDR regime and are incomplete. It was therefore not unusual to find for one enterprise conflicting claimants. To be added the fact that in most cases the original owner was not anymore alive, and property claims were therefore also subject to disputes over inheritance. A complicated administrative procedure was necessary to assign the first legitimate owner. A hypothetical example will help to understand the degree of difficulty. Assume a small enterprise, which belonged to a Jewish family. The family was able to sell the property to a member of the National Sozialistische Partei just before they left Germany in the early 1930s. The member of the NSDAP (Nationalsozialistische Deutsche Arbeiter Partei) escaped after the war to West Germany and left the enterprise behind, which was then sold by the communist government to a GDR citizen. Under the forced sale of 1972 the enterprise went back into state-property but was later re-privatized under the Modrow government. This kind of situation was perfectly possible and explains why after the unification 40,000 ownership claims on 17,000 enterprises were filed. Until June 1992 only 4700 of these cases were settled. The establishment of ownership through reinstitution of the previous owner, became the bottleneck of privatization and successful restructuring in East Germany. The mere restitution claim on the whole of an enterprise, a part of it, or the real estate on which the enterprise was built, produced an immediate obstacle and blocked the process of privatization by the Treuhandanstalt until the legal settlement. As long as ownership rights were not clearly pronounced, potential investors can not be attracted, and the enterprise will forgo investment opportunities. Secondly, as long an enterprise is not registered in the title record, banks will not grant mortgages.

The sound foundation of a free market economy are clear cut property rights. As long as these rights do not exist, the market can not work efficiently. The restitution in kind brought about uncertainty, which was a main hindrance of the proper functioning of the market and which brought about high macro economic costs such as lower growth rates, lower investment rates and more unemployment.

Critiques of the Einigungsvertrag with respect to restitution provisions proposed to concede compensation rather than restitution to former owners. They argue, that considering the costs for administrative work, compensation would not have been more expensive than restitution. Additionally, following the principle of compensation would have had the advantage to separate the procedure of assigning original ownership from privatization. In this way the investor could have become legal owner before the settlement of compensation would have been finished. The duration of the settlement would not have influenced the delay of investment and would therefore not have hurt the restructuring of the enterprise. The necessity to restructure the East German economy in the shortest delay would have justified to set community interest before individual interests. The counter-argument is, that ownership rights should be safeguarded even under the most difficult circumstances in order to defend the principles of a free market economy. In the specific case of East Germany the fundamental notion of ownership deviated from the essential. In the free market economy private ownership is an incentive and a mean for prosperity, progress, and innovation. Private property is not only perceived as an end in itself. However, the way the Einigungsvertrag treated the problem of ownership, created in many cases the greatest obstacle to achieve a free market mechanism.

The government reacted to the severe critiques of economists, local politicians and academics by introducing the Hemmnisbeseitigungsgesetz (Law to remove impediments) in March 1991. The Law provided for a renovation with respect to ownership rights. The Law did not question the principle of restitution in kind but imposed limitations to its validity. The original owner can only take physical possession of his property if he can guarantee the continuation of the enterprise and secondly, if he can assure enough investment to restructure the enterprise. If he is not able to do so, an investor with a credible investment concept will have priority. The original owner will then receive a financial compensation which depends on the market value of the enterprise. However, the difficulty to identify the original owner is not resolved yet. Investment concepts of original owner and new investor have to be available and compared, otherwise the enterprise can not be assigned to either one. The original owner is still in a position to delay the privatization process whereby valuable time is getting lost. Experts are talking about ten to twenty years before restitution claims will be finally settled. Meanwhile enterprises will close down and employment will get lost not because of inefficiency with -respect to production but because of inadequacy of the legal system. Even ' if the government would favor today an about-turn of the restitution principle, it would be up to the Constitutional Court to decide whether the Law may be changed or whether Germany has to live with the consequences of the unification's cardinal error, i.e. the restitution.

Excerpt from Treuhandanstalt German Privatization Program
Mrs. Gabriel Issa
Submitted to Professor Ali M. S. Fatemi, Chairman, Department of Economics at The American University of Paris Submitted in Partial Fulfillmenmt of Requirements for BA in International Economics, Spring 1995