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On the Costs and Effectiveness of Tarjeting State Employment: Germany in the 1990s and China in the 2000s

The German unification process imposed a significant price-cost squeeze on eastern firms. Important technology differences between the East and the West generated high pressures on the competitive position of eastern manufacturing firms when product and factor markets integration took place. In order to avoid mayor employment and output costs, the government subsidized eastern firms. A similar process is expected in China after accession into the WTO. The restrictions to foreign firms to access domestic markets have to be lifted, and hence significant cost pressures on native, specially state-owned enterprises, are expected. The projected employment shift from native to foreign firms suggests that the Chinese government may decide to slow down the transition process, as Germany did. This paper estimates the fiscal costs of artificially targeting state employment through product price subsidies rather than allowing factor reallocation. The subsidy needed to increase East Germany’s manufacturing employment by 1% was around 0.9% of value-added prices, compared to a 1.2% subsidy if China targets state employment or 18.7% if China targets native employment. These numbers imply that the annual cost per worker targeted in Germany more than 13 times the cost per worker in China.