austin-murphy-the-triumph-of-evil

198 THE TRIUMPH OF EVIL
ment (which strictly controlled prices, wages, and therefore return on
investment), the maximum black market exchange rate X would have to
satisfy the constraint
(6-X)( l.18)9 2: 5(1 .03)9, or
X� M4.5/DM. (B- 1)
If the exchange rate were in excess of M4.5/DM, the cash savings
of M6-MX from using the black market, invested at 18% for 9 years,
would not grow to an amount in excess of what could be earned from
the alternative strategy of exchanging at the official I: I exchange rate
and putting the mandatory M5 in the 3% savings account.
Thus, the black market exchange rate would be close to or less than
the all-important cost of earning a OM in exports. This hypothesis is
supported by Murphy's ( 1992b) empirical finding that, even without the
unrestricted opportunity to exchange money legally, the black market
exchange rate was strongly affected by the cost of earning a OM export.
In addition, while Murphy ( 1992b) also found evidence that the black
market value of the East German mark was negatively influenced by
higher prices in West Germany (implying a high degree of inelasticity
of demand for West German goods relative to price due to the existence
in East Germany of a shortage of modem Western goods), such an effect
might be alleviated under the current plan that allowed greater imports
of Western goods (as the same Murphy study found that the demand
inelasticity problem had been alleviated in the past by enhanced political
recognition for East Germany, which opened up the opportunity for
greater importation of high-tech Western goods, and by increasing the
amount of legal imports from West Germany in general).
It is quite possible that the black market exchange rate in equation
(B-1) greatly overestimates the number of East German Marks that
would be needed to buy OM. In particular, a high tax rate was levied
on profits in East Germany, whereas interest on savings accounts was
not subject to tax (Der Tagesspiege/, 1989e), and so the return on a
commercial investment would have to be put on a comparable after-taX
basis. For instance, with a tax rate of 50% levied on profits in excess � f
M25,000 in East Germany (Buero des Ministerrates, 1966), the maxtmum
exchange rate from the adjusted foregoing inequality would be
X� 6-[5( 1 +.03)"/( 1 + {.18x.5})�) = M3.0/DM I. (B-2)
CHAPTER 5 199
Even the M3.0/0M exchange rate might overestimate the true black
market rate that would exist. In particular, the tax rate on domestic
company profits was as high as 90% on profits in excess of M250,000,
which might be relevant to the richest East Germans who might be
the ones most likely capable of investing their money commercially.9
East Germans faced with that marginal tax rate would optimally invest
any money saved from using the black market into the traditional taxfree
money market checking accounts earning 3.25% (since the aftertax
yield on commercial investments would be only 18%{1-.90}=1.8%,
which is lower than 3.25%). As a result, the boundary exchange rate
might be as low as
X� 6 - {5(1 + .03)9/( 1 + .0325)9} = Ml.l/DM. (B-3)
Thus, black market exchanges might be very close to the 1: 1 official
exchange rate. In addition, because most East Germans did not have the
opportunity, know-how, or desire to conduct lucrative investments on
their own, and because black market exchanges would be illegal (creating
risk of imprisonment and/or fines, as well as possibly resulting in
a negative criminal status and psychological worries), there might be
very little black market activity at all. West Germans and other fo reigners
might therefore encounter some difficulty in finding East Germans
fro� whom they could buy M, and so they (being also subject to simi­
lar nsks) might decide instead to exchange their money legally with
an East German bank at 1: 1 when making purchases inside East Ger­
lllany.'o These extra OM so obtained would reduce the amount needed
to s_ubsidize East German imports and therefore increase the amount
available for East German investment.
Risk of Different Costs of Earning DM Export Revenue
An in-depth time-series study by Murphy ( 1992b) indicated that the
. · · rt
COst
.
of earn tng · a 0 M m exports was unaffected by mcreases m expo s
or tmpons fi ur d b · ·
forei
rom nest Germany, as well as unaffecte y mcreases m
to be gn trade in the aggregate. As a result, the constant M4.4 assum � d
the �x � nded to generate each additional OM 1.0 in export revenue m
h��gtnal model seems i
reasonable. However, it is possible that a very
the 1.'0CJ'ease in foreign trade (possibly mandated by excess demand at
d' :1 exchange rate) might result in additional costs, such as increased
'stribution d · · an resource reallocation expenses, at least tmha · 11 Y· 11 S uc
h