Eastern Germany since unification: wage subsidies remain a better way

Abstract

In Spring 1991, we argued that the centrepiece of German policy towards unification should be a universal, temporary wage subsidy in Eastern Germany and the elimination of all other subsidies. Subsequent events have strengthened the analytical case for and practical importance of this policy. This paper describes the performance of the Eastern German economy since unification, the reasons behind it, and the principal policy responses. It then identifies the specific market failures attributable to unification and shows that the various current policy interventions are poorly targeted. Finally, the paper sets out our proposal, explains why it minimizes distortions, and deals with common objections to a wage subsidy.