Migration, Wages, and Tradition: Obstacles to Entrepreneurship in East Germany

For the last decade, the East German economy has been suffering from high unemployment and low economic growth. Policy makers often point to the lack of entrepreneurship as one of East Germany’s main problems. This paper addresses the question of how East Germany’s integration into an established economy, West Germany, may have hindered a fruitful development of entrepreneurship and how this may have affected economic growth. I build a model economy that places Lucas’s [1978] span-of-control model into an overlapping-generations framework. Following Hassler and Rodŕıguez Mora [2000] managerial talent is defined as a combination of two factors, intelligence and entrepreneurial parental background, and growth depends on the intelligence of entrepreneurs. In East Germany, the lack of entrepreneurial parental background makes intelligence the decisive factor in occupational choice and more intelligent entrepreneurs should contribute to high growth rates. However, three key aspects of its integration into West Germany inhibit this mechanism: 1) the unrestricted mobility of East Germans to the West, 2) the policy of fixing East German wages as fractions of West German wages, and 3) the importance of family tradition for entrepreneurship in West Germany. Counterfactual experiments show that eliminating any of these three aspects leads to more entrepreneurs, less unemployment, and higher economic growth in East Germany. JEL classification: F15, E24, J22