The Macroeconomic Effects of German Unification: Real Adjustments and the Welfare State

We study the effects of German unification on macroeconomic variables in a model with capital accumulation, skill differences and a welfare state. The integration of two economies differing in capital holdings and skill distribution is similar to a mass migration of low-skilled agents holding no capital into a foreign country. In the absence of a welfare state, capital holders benefit over the business cycle and depressive long-run consequences ensue. With a welfare state depressive long-run effects are amplified. We examine two policies which may reduce the negative long-run effects. Open economy and sticky wages extensions are considered.