Catching-up of East German productivity to West German levels has completely faded out since the mid-1990s. The remaining productivity gap cannot be attributed to an inferior capital endowment or qualification deficiencies of the East German labor force. Instead, it appears to be the result of an inappropriate design of industrial policy which concentrated on the subsidization of physical capital and largely ignored the advance of human capital- and service-intensive industrial structures. East Germany will have to face another wave of painful structural adjustment when capital-intensive industries are no longer protected from competition by public subsidies.