Learning Capitalism the Hard Way--Evidence from German Reunification

Abstract

We develop a model of firm learning in volatile markets with noisy signals and test its predictions using historical data from the Ifo Institute's Business Climate Survey. We find that firms' forecasts improve as they age. We also exploit German Reunification as a natural experiment where firms in the East are treated with ignorance about the distribution of market states. As theoretically predicted, Eastern firms make larger forecast errors than Western ones, but this gap gradually closes over the decade following Reunification. The slow convergence rate stems from differences in expectations rather than market conditions. We also find evidence for the model's predictions that improvements from learning are faster where market signals are noisier.