Eastern Germany’s recovery from the “unification shock” has been characterized by deep
structural change – with apparent repercussions for the West as well – and an integration
process involving both capital deepening (extensive and intensive investment) and labor
thinning (net out-migration). I propose a constant-returns neoclassical model of economic
integration which can account for these facts. Adjustment costs determine dynamics and
steady state regional distribution of production factors. The model also explains persistent
wage and capital rate-of-return differentials along the equilibrium path. Under competitive
conditions, observed factor price differentials contain information on those adjustment costs.