Supporting inefficient firms with capital subsidies: China and Germany in the 1990s

With different emphasis during the 1990s, both China and Germany introduced policies to lower the cost of capital for productivity-backward domestic firms. Capital subsidies compensated for the rental rate gap between state-owned enterprises (SOEs) and nonstate-owned enterprises in China and between eastern and western producers in Germany. In Germany, excessive wage pressures immediately following unification decreased the return to capital in the East to negative rates. However, productivity convergence and the decrease in wage pressures led to a rental rate gap of around 70% by the mid 1990s. Throughout the decade, the rental rate gap was higher in China than in Germany due to a large productivity gap and to high non-wage benefits provided by SOEs. Overall, the higher cost of the policy in China can be explained by the more generous coverage of capital subsidies. Journal of Comparative Economics 34 (2) (2006) 377-401.