Wages in Eastern Germany have risen in excess of productivity growth. The usual argument is that this has been one of the main reasons for the unprecedented level of mass unemployment which has emerged in this decade. This paper argues, however, that the growth of wages, in combination with investment subsidies, has resulted in a period of “creative destruction” which has enabled the economy to embark on a high‐technology convergence path and to benefit from dynamic forces which the usual static analysis is forced to overlook. Such a unique approach to the restructuring necessary in transition was facilitated by the unification of the former GDR with developed social market economy with the ability to shoulder many of the associated costs, at least for a time. The need now is for the recognition of profit as a motivator of indigenous investment in Eastern Germany and this calls for a prolonged period of wage restraint, during which time progress towards lower levels of unemployment can be achieved.
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