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Factor Price Distortions and Public Subsidies in East Germany

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  • Sinn, Hans-Werner

Abstract

Economic development in East Germany is not uniform. The building and construction industry is booming but manufacturing industry is stagnating. The paper argues that severe distortions in relative factor prices are the cause of the dichotomous development. These distortions result from excessive wage increases and investment support large enough to make the cost of capital negative for East German industry. The negative cost of capital implies that this factor in fact mutates into an economic good whose `production' the firm tries to increase by using more of other factors. It is suggested that the support for investment be abandoned and that a political compromise be sought, whose aim is to reduce the planned wage rises. The compromise could include an investment wage agreement for insider workers and a distribution of the stock of public housing to prevent workers from suffering wealth losses. It would be a Pareto improvement avoiding the large welfare loss incurred by the policies currently pursued.

Suggested Citation

  • Sinn, Hans-Werner, 1995. "Factor Price Distortions and Public Subsidies in East Germany," CEPR Discussion Papers 1155, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:1155
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    Citations

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    Cited by:

    1. Barbara Dluhosch & Daniel Horgos, 2008. "Wage vs. industry subsidies: coping with technology related unemployment in a globalized economy," International Economics and Economic Policy, Springer, vol. 5(4), pages 371-388, December.
    2. Strauch, Rolf & von Hagen, Jürgen, 2000. "East Germany: Transition With Unification - Experiments and Experiences," CEPR Discussion Papers 2386, C.E.P.R. Discussion Papers.
    3. Fuest, Clemens & Huber, Bernd, 2000. "Why do governments subsidise investment and not employment?," Journal of Public Economics, Elsevier, vol. 78(1-2), pages 171-192, October.
    4. Klodt, Henning, 1996. "West-Ost-Transfers und Strukturprobleme in den neuen Ländern," Open Access Publications from Kiel Institute for the World Economy 1677, Kiel Institute for the World Economy (IfW).
    5. Klodt, Henning, 1999. "Industrial policy and the East German productivity puzzle," Kiel Working Papers 943, Kiel Institute for the World Economy (IfW).
    6. Bijie Ren, 2008. "The regional effects of marginal wage subsidies," Psychometrika, Springer;The Psychometric Society, vol. 3(4), pages 598-626, December.
    7. Westermann, Thomas, 1995. "Das Produktionspotential in Ostdeutschland," Discussion Paper Series 1: Economic Studies 1995,04, Deutsche Bundesbank.

    More about this item

    Keywords

    East Germany; Factor Prices; Subsidies; Transformation;

    JEL classification:

    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • H2 - Public Economics - - Taxation, Subsidies, and Revenue
    • P21 - Economic Systems - - Socialist Systems and Transition Economies - - - Planning, Coordination, and Reform

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