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Monday, November 1, 1999

Germany and the Third Way

Germany Is No Longer the Powerhouse It Once Was

Norman Barry is professor of social and political theory at the University of Buckingham in the United Kingdom. He is the author of Business Ethics (Macmillan, 1998).

At least two things exercise political and economic commentators on Europe: the meaning and policy significance of the “third way” and the current malaise in the German economy. There is close connection between these two issues, though it is not quite the one that modern statists have in mind. But it is easy to show that the relative decline of the German economic “miracle” is directly linked to its adoption of economic and social policies that are recommended for a future social democratic Europe.

Advocates of the third way in the United States and the United Kingdom have similar, although watered down, things in mind. The European Union is itself suffering from the false promise of the latest modest anti-capitalist medicine. Yet the German experience provides an almost laboratory experiment of the errors of “capitalism with a human face,” the “social market economy,” “social democracy,” or any other version of the third way. It is not enough to condemn the third way’s political economy merely because President Clinton supports it. There are much better intellectual reasons for rejecting this currently fashionable doctrine.

No Miracle

For most of the postwar period (West) Germany, outside of Switzerland, was the most successful economy in Europe. Her recovery from the ruins of war was truly spectacular. The tragic irony is that just as countries in the rest of Europe ignored the reasons for this success so they will misunderstand the explanation of her current travails. For her early economic record was the result of the deliberate, almost planned, adoption of a free-market economy, which was completely against the trend of the times. There was no Wirtschaftswunder (economic miracle), only the rigorous implementation of well-tested economic policies based on sound theory. Germany’s problems today stem from the retreat from this over a 30-year period.

Germany is celebrating the 50th anniversary of the founding of the Republic but the real event to commemorate is the radical free-market economic program introduced by its postwar economics minister, and later chancellor, Ludwig Erhard, in 1948. At the time, the agony of Germany’s postwar attempted adjustment to economic reality was exacerbated by the continuation of a ruinous system of wartime planning under the Allied Control Commission. Interventionists though the advisers to West Germany were, they all agreed that there had to be currency reform; the Reichsmark was worthless and little used for whatever exchange actually took place. But Erhard, chief official of the Administration for Economic Affairs for the British and American Occupation Zones, managed, by a superb piece of political chicanery, to engineer a wholesale reduction of price controls under the noses of his Keynesian advisers. An early critic was John Kenneth Galbraith, who began his long career of highly profitable private punditry and catastrophic public economic error in postwar Germany. He wrote an influential article that promised misery and poverty if Erhard’s policy were to be continued. He was, of course, engaged in writing his book on the theory of price control at the time.

But Erhard pressed on with his economic liberalization. There was probably not a majority in favor of it, and a majority was only narrowly achieved in the elections of 1949, after the policy’s prophylactic effects were visible to all but the most blinkered of central planners.

Liberalization was not popular with the political elites. Erhard was never very close to the Christian Democrats, many of whom remained wedded to a form of interventionism and control derived from Roman Catholic social teaching, and the Socialists remained formally Marxist until 1959. Still, the reasons for Germany’s success were too obvious to ignore (though Britain remained oblivious to them until 1979), and the country was quickly won round. The Catholics managed to combine the market with religion, and the Socialists became, albeit for a short time, even more pro-capitalist than some of the Christian Democrats. A prominent Social Democrat member of the coalition governments in the 1960s and 1970s, Karl Schiller, actually resigned over a free-market issue. The Social Democratic party has now slipped back to its old socialist ways, and these have been reinforced by the usual contemporary fads, notably environmentalism (the present government is a coalition of Social Democrats and Greens), anti-Americanism, and careful and diluted, but not completely rejected, anti-capitalism.

Seeds of Decline

The seeds of German decline were planted long ago. The intellectual error was by no means confined to the Social Democrats. All major political movements have been infected with the virus of the third way, with its illusion that there is a morally appealing midway point between capitalism and socialism and that we can indulge our social consciences with welfarism and heavy economic regulation without seriously corroding the market society. It is highly successful capitalist societies that are peculiarly vulnerable to these illusions; they have little resonance in Poland or the Czech Republic.

Their origins in Germany date back to the foundation of the Erhard system. There were two interconnected social visions that governed political and economic life in postwar West Germany: the idea of Ordo-liberalism—that is, the peculiarly German version of classical liberalism—and die Soziale Marktwirtschaft (social market economy). The values, policies, and personnel of the two intellectual movements overlapped. All German market theorists had some doubts about unregulated capitalism. Most particularly they thought there was a tendency for free contract to produce, quite spontaneously, a non-contract society through the emergence of monopolies and cartels. The German skeptics were encouraged by their own experience; the German economy had been badly cartelized in the early decades of the twentieth century (which ultimately enabled Hitler to run a “non-socialist” command economy). The Ordo-liberals thought that mistaken legal decisions had produced this outcome. In their Wirtschaftsordnungspolitik, the legal and political order of a free economy, the state was given the responsibility of preserving, artificially, the foundational rules of a market society, though they ought to have realized that free international trade is the most effective guarantor of a noncartelized economy. The Germans were very much influenced by American antitrust law.

Both “liberal” movements believed in some state welfare but it was much more pronounced in social market theory than in Ordo-liberalism. Alfred Müller-Armack, a member of Erhard’s government, coined the deadly phrase “social market economy,” and he actually believed in a new concept of the person—neither capitalist man nor socialist man—who would emerge from a properly and ethically organized market society. Erhard himself probably regarded the social market economy as a morally convenient mask behind which he could advance his genuine market reforms. But at least the German liberals thought that welfare policies should be marktkonform, that is, consistent with an efficient exchange system; they should not encourage the emergence of a dependency culture.

However, as the German system developed, it was the “social” element that began to predominate over the “market,” and throughout the 1960s the country began to resemble a Scandinavian welfare state, to which its liberal theorists had originally been vehemently opposed. Many reforms were quite debilitating. Unemployment pay was, and is, close to the wage paid for work; sick leave is very generous; and more or less free education can last almost forever. And, as any traveler will tell you, most shops are closed on Saturday afternoon. Given the reduced attractions of work (and German nonwage labor costs are the highest in the world) is it any wonder that German unemployment is 11.5 percent? The original Bismarckian state pension scheme was foolishly extended and its unfunded foundations, in combination with a declining birth rate, promise to present the country with a horrific problem in about 20 years. Government spending, which was kept below 30 percent of GDP under Erhard, is now above 50 percent.

Social Consensus

One reason for West Germany’s original success was its social consensus. There was none of the confrontational attitude between capital and labor that so disfigured Britain before Margaret Thatcher. Once trade unions had accepted the market system, they were anxious to cooperate in what became a common enterprise. But this benign industrial culture had its downside. It produced a certain insularity and a hostility to the takeover mechanism: nothing much should change, and nobody should lose his or her job. Fearing the concentration of industry, the Ordo-liberals themselves gave this attitude some intellectual justification. They and the postwar government set up a cartel office, which sedulously sought out any innovator who might get a fraction more than the permitted market share.

German companies have never been concerned about delivering shareholder value. Indeed, they have traditionally financed their investment by bank debt, giving the lie to American business ethicists who worry about the immorality of corporate raiders loading up American corporations with junk-bond debt. Those ethicists looked to Europe as an example of probity, but as it turned out, the “greed-driven” Anglo-Saxon model of corporate governance proved highly flexible and innovative.

What nobody realized in Europe was that the predator breaks up companies, spins off unwanted parts, fires layers of redundant managers, and produces leaner and fitter enterprises. Such restructuring has been the foundation of America’s economic success since the 1980s. But in Germany’s much-vaunted consensus, the raider is subject to opprobrium and ostracism, especially if he is a foreigner. With banks (which, unlike those in the United States, hold substantial equity stakes in German companies), trade unions, and local interests forming invincible coalitions against change, German managers are secure, as they were in 1997 when Krupp tried a reverse takeover of Thyssen in order to rationalize the steel industry. The stakeholder groups got together and turned a hostile bid into a tame merger, with guarantees of no unemployment. Even Italy seems to be ahead in adopting Anglo-Saxon methods of industrial reorganization. The computer company Olivetti has just completed a spectacular $60 billion takeover of Telecom Italia against a formidable array of stakeholders. The takeover strategy, and motivation to maximize shareholder value, is now spreading to Europe. But Germany is far behind.

Fear of Inflation

Of the classical-liberal principles that undoubtedly inspired West Germany in the early postwar period, only a belief in sound money survived the onslaught of social democracy. Of course, Germany’s experience of runaway inflation in the 1920s made the country sociologically equipped to cope with the occasional pains of monetary rigor. Keynesian demand-management policies were eschewed from the early days, for excellent microeconomic reasons. An independent central bank, the Bundesbank, resisted all political pressures to relax what was basically Chicago-style monetarism (“just watch the monetary aggregates”).

But by the 1960s macroeconomics became fashionable, and successive governments became obsessed with tinkering with the aggregates; committees were set up and suggestions made by “wise men” for improving overall performance. But the Bundesbank retained its virtue (and the people their pride in the German mark) right up to reunification, when Helmut Kohl’s government compelled the Bundesbank, for overtly political reasons, to sanction a catastrophic one-to-one currency swap, the East German mark for the Deutsche mark. The former was pretty much worthless, and this arrangement, plus the granting of partial West German welfare “rights” to the former East, undoubtedly made the union of the two countries more difficult than it need have been.

German monetary chastity clearly could not survive the seductive lure of reunification. The next question on the macroeconomic agenda is whether the Euro, the new currency for the continent, will provide a satisfactory surrogate for the beloved mark. The Bundesbank had established a reputation for incorruptibility precisely because of its proven probity: prior to reunification no politician could compete with it in the public’s estimation. One of the first things the controversial leftist Social Democrat Oskar Lafontaine did in his brief period as minister of finance in the new Social Democratic government was to put pressure on the European Central Bank to relax its Bundesbank-type monetary rigor. That failed, but one wonders how that institution will survive a coalition of Spanish, Italian, French, and other politicians demanding inflationary employment policies.

With excessive social welfare and a sclerotic industrial economy, Germany is no longer the powerhouse it once was. An early Ordo-liberal, Wilhelm Röpke, once said that “like pure democracy, undiluted capitalism is intolerable.” He was a pioneer of the idea of the third way, but even he would be distressed at what has happened to his country.* Perhaps the major problem with Ordo-liberalism was its neglect of public choice. Its adherents really did believe that once people had experienced the joys of the social market they would have less reason to rely on the familiar human motivations and on the historically validated legal and market constraints. Social-market theorists had an “elevated” view of human nature: When politicians and public officials were imbued with a sense of community and reinforced by the glue of solidarity, no one need worry about things like antisocial rent-seeking; moral hazard would not be a problem for enlightened people in a generous welfare system; and managers of industrial corporations would be disciplined without stockholder pressure and the threat of raiders.

*Editor’s note: See Richard Ebeling, “Wilhelm Röpke: A Centenary Appreciation,” The Freeman, October 1999.

But the more astute German commentators learned early on that there is no feasible third way. All economic proposals that run counter to the laws of economics are eventually defeated by these inexorable processes; they may be a little slower to operate than those of physics, but they are just as compelling. Germany has breached just about every one of them in the last 30 years. As Vaclav Klaus, the former Czech premier, put it: “the third way is the third world.”

  • Norman Barry (1944-2008) was a professor of social and political theory at the University of Buckingham, UK, the country’s only private university.