This paper builds a model of transition following economic reforms and analyzes the different experiences of two Central European economies after 1990. East Germany started its transition with rapid growth in output per working-age person and experienced a dramatic increase in its very low initial capital income share of output. Poland experienced low growth in output per working-age person while maintaining a fairly constant capital income share. Reform is modeled as gaining access to a higher productivity technology, embodied in new plants. As new, high productivity plants are built, the existing low productivity plants decrease their production and eventually shut down. During this process, the capital income share varies. Two policies are incorporated in the model: transfers from the rest of the world and wage increases due to political pressure. The model quantitatively captures both the East German and Polish experience.
