A "marginal" tale of two Germanies: Accounting for the systemic divide

The comparative economic performance between the former socialist German Democratic Republic (GDR) and the capitalist Federal Republic of Germany (FRG) remains inconclusive due to valuation problems. We address these problems by applying wedge-growth accounting to a newly compiled dataset. More precisely, we compare the allocation efficiency using wedges between marginal utility and productivity, as well as Total Factor Productivity (TFP) growth. Wedges in marginal utility account for binding quantity constraints in GDR's goods and FRG's labor market. We analyze the resulting unitless wedges and swap them in an equivalent growth model for the two Germanies to quantify their impact on output and economic welfare. The analysis reveals that the consequences of GDR's rationing were multiple times more drastic than FRG's unemployment. An observed faster output growth in the GDR stems from excessive labor input-depressing consumption-based welfare by a fourth-rather than from physical capital or TFP. Instead, GDR's economic activity fell comparatively ten years further behind due to lower TFP growth. Lastly, persistent, substantial net inflows increase GDR's welfare by 25 %.