The Economics of Transition 3, 1995, pp. 403-426, CES Working Paper No. 67, September 1994.
Capital and labour are the two most important economic factors and their efficient use is a basic condition for economic transformation to be successful. The East German communist system always had problems with the optimization of capital use because the labour theory of value denied, on ideological grounds, the necessity for paying interest as the price of capital use. lt was only at a late stage, with the introduction of the new economic system for planning and directing the economy (NÖSPL) in 1963, that the necessity for a "production fund levy" to prevent the wasteful use of capital was recognized. The levy introduced was, however, not high enough to achieve this aim. Tue GDR economy continued to be hopelessly inefficient.
One would have hoped that introduction of the market economy would make things right at last. The market economy, by allowing the prices of capital and labour to reflect their relative scarcities, provides sufficient motivation to use these most important factors of production efficiently. Alas, the reality tumed out to be altogether different. Instead of capital costs being allowed to increase in East Germany, subsidies were introduced after unification which pushed these costs down to negative levels. The subsidies made the situation even worse than it had been before the introduction of the NÖSPL. And the share of wages in the manufacturing sector was driven up until it reached a value of we11 above one, far higher than the most ignorant propagandists of the labour theory of value would have demanded. This paper is concerned with the dangers economic development in the New Länder has been exposed to as a result of the distortions in relative factor prices.