Germany: From the Market to Socialism—and Back?

Germany is still the third biggest economy in the world, but like the second (Japan) it is suffering from rising unemployment (approaching four million or 10 percent of the workforce), massive capital flight, a growth rate approaching
zero, workers who were once a legend for productivity but who are now over-educated and reluctant to do a full day’s labor without consulting a rule book of “rights” (a law restricting shopping on Saturday afternoon has only just been repealed), and enormous present and future welfare obligations.

It is fashionable to blame the current crisis on macroeconomic issues, such as adopting the Euro and fixing the country to high interest rates enforced by the European Central Bank, a restraint on budget deficits (imposed, ironically, on Europe, at the insistence of Germany herself), and the foolish one-to-one swap of the worthless East German currency with the Deutschmark at reunification. These are important, but Germany’s travails predate all this, and her fundamental structural problems would have eventually generated a national economic crisis whatever the monetary regime.

The problems can only be understood by going back to the founding of the West German republic after World War II. Under Allied occupation the country was rendered unproductive by a hopeless planning system and an unusable monetary regime (the Reichsmark). The country faced starvation, with women forced into prostitution and people begging on the streets or hunting for food in rubbish bins. The Allied occupying forces, surrounded by Keynesian advisers, knew something had to be done but could only think of reforming the monetary system. The country was saved in 1948, however, by an obscure economics professor, untainted by Nazi connections, who held a fairly minor post in the economic administration. He was instructed to effect the change to the Deutschmark, but this man, Ludwig Erhard, did more than this. Under the protection of monetary reform he repealed overnight almost all the constrictions and regulations on pricing and output that had brought the economy to its knees.1 The Nazis hadn’t socialized the economy but had made it inefficient; and it was made unworkable by the occupying powers.

With the exception of one U.S. military commander, the Allies were opposed to Erhard’s free-market reforms. One American opponent in Germany at the time was John Kenneth Galbraith, who in a famous newspaper article said that wholesale marketization had never worked and would fail now. This must have been the first of his many legendary mistakes, for very quickly the West German economy recovered.

It is certainly true that the reforms were initially unpopular in the country. Conveniently, the first elections in the postwar Republic were held in 1949, after the reforms had taken effect. The conservative Christian Democrats (CDU) were not keen on them, but went along; the Social Democrats(SDP) were still Marxists; and the influence of Catholicism was a permanent obstacle to the individualism of the godless market. The German Free Democrats have always been the most free-market party, but their pro-capitalist credentials have always been diluted by support for some statism and agricultural protectionism.

To the chagrin of almost everybody important, the reforms worked. Under the wise stewardship of Erhard, who had become finance minister, West Germany made a remarkable recovery. It had the freest market in Europe, outside Switzerland, and within a decade had approached the top of the economic league. While Britain was struggling under heavy nationalization and extensive and costly welfare, West Germany prospered. Chancellor Konrad Adenauer was probably skeptical of the market, but was too interested in world affairs to bother about economics, so Erhard had pretty much a free hand.

Erhard revitalized the economy. In those halcyon days public spending was kept well below 30 percent of GDP. (It is now approaching 50 percent.) By 1959 the socialists had formally abandoned Marxism and became, for a short period, enthusiastic capitalists. Indeed, an SDP finance minister, Karl Schiller, resigned from the grand coalition (CDU and SDP) on a freemarket issue in the early 1970s. Now it has slipped back into old statist ways. Indeed, a dominant figure in Social Democratic politics is Oskar Lafontaine. He had been finance minister in Gerhard Schroeder’s government and was even too left-wing for him. Lafontaine was forced out of office and immediately wrote a book called The Heart Beats on the Left.

However, the consensus that had emerged under Erhard was pro-market, the opposite of that social agreement about policy that Margaret Thatcher did so much to destroy in Britain. (Conservatives before her were Keynesian, welfarist, keen supporters of the National Health Service, and in no mood to break up the socialism that the 1945-51 Labor Government had introduced.)

Origins of the Current Crisis

So, is the solution to Germany’s current sclerotic economy to be found in a new Erhard? Yes, but before we go looking for one, we must understand how it all went wrong, for the ultimate failure of the Erhard program to survive the vicissitudes of democratic politics contains timeless lessons. The ideological foundations of the Erhard revolution contained two elements that in the beginning produced harmony (albeit precarious). But ultimately one triumphed — and it was the wrong one. Hence, Germany’s current difficulties.

Erhard’s system drew upon two doctrines: Ordoliberalism2 and the Sozialemarktwirtschaft (social market economy).3

Ordoliberalism was clearly free market, and its founder, Walter Eucken (who tragically died in 1950), had produced in the war years a coherent theory of the order of a market economy. It had a minimal state and an efficient legal system designed to preserve freedom. However, monopolies and cartels were forbidden, partly on the grounds that such things had enabled Hitler to run a war economy without having to nationalize anything. Austrian economists were critical of this aspect of the reforms. (Nevertheless, F.A. Hayek was a friend of Erhard, who was an early member of the Mont Pelerin Society.) Ludwig von Mises was especially scathing about the action taken against cartels, for he believed that a free market would break them up and those that survived would have a market rationale.4 However, other economists sympathetic to the market approved of the anti-cartel measures. The Ordoliberals, who believed that cartel agreements violated German law, had long criticized an 1897 court decision upholding a private cartel arrangement that sought to keep competitors out.

It is probably true that the fear of cartels was exaggerated and their pre-war longevity was largely a function of protectionism. Postwar anti-cartel action was too much influenced by American antitrust legislation.

There was a determined eschewal of Keynesian demand-management policies and a fear of monetary disorder and of tradeunion power. These last two were thought to be a likely result of Keynesianism. The market was ultimately self-correcting, and the central bank should be independent.

The Bundesbank was a big factor in West Germany’s revival. It followed a more or less Chicago policy of closely watching the monetary aggregates so that the country did not repeat the hyperinflation of the 1920s. One of the Bundesbank’s final gestures was to oppose the aforementioned monetary swap with the currency of the former East Germany. It is now no more than a branch office of the European Central Bank, and the oncebeloved Deutschmark is becoming a distant memory. Still, even before Erhard’s death there had been ominous signs: committees of “wise men” were set up to oversee macroeconomic policy. Keynesianism was creeping in.5

In contrast to the Ordoliberals, the social-market thinkers, one of whom, Alfred Muller-Armack, was a prominent member of Erhard’s government, had a much broader agenda. While everybody, including the Ordoliberals, accepted Bismarck’s welfare state, with its pensions and health and unemployment insurance, the Scandinavian type system was nevertheless rejected. However, in the 1960s costly welfare reforms, including a potentially ruinous extension of the pension system, produced exactly that. The social element in the market economy gradually displaced the market.

The original reluctance to embrace full-fledged welfare was for two reasons: it would have a deleterious effect on incentives and would undermine the moral basis of a liberal society (free and independent individuals). But the social-market people were too relaxed about this; they actually believed that the new West German order would produce enlightened persons who would not need the normal incentives of the market to produce responsible behavior.

How wrong they were. Germans are normal people. They won’t work unless they have to, and now it is often beneficial not to get a job and rational to stay in school until age 30. They have relished the Scandinavian welfare state that has been gradually introduced. It is now technically irrational to work. Unemployment benefits are too good: and since these are partly financed by employers’ contributions to Social Security, capitalists are reluctant to hire new workers. (Trade-union power makes it difficult for employers to implicitly subtract these contributions from wages.) German nonwage labor costs are now the highest in the world, reaching $20 an hour in many cases. In some respects German welfare is worse than Scandinavian. At least in Sweden there is a work test before a young person receives welfare. Also, in that country corporation taxes are relatively low so that the inward flow of capital is not discouraged. Despite protestations that it would discourage the capital inflow, one of the first acts of the Social Democratic government, elected in September 2002, was to raise company taxes.

German Industrial Consensus

The much-vaunted consensus in the Erhard economy worked well for some time. West Germany was not disfigured by the strikes that afflicted Britain before Mrs. Thatcher. Unions were fully integrated into the market, had mandatory representation on the supervisory boards of companies, and deliberately abjured the confrontational tactics of their British counterparts. There were few statutory limitations on takeovers (though a long-standing rule forbidding any one person voting more than 10 percent of his stock has only recently been repealed), but there was a social disapproval of corporate raiders (foreigners especially) who might threaten jobs. Thus the industrial reorganization that a country must go through if it is to remain competitive (Schumpeter’s “gales of creative destruction”) has been deterred by the too-much-admired consen-sus. German banks, unlike those in the United States and Britain, are stockholders in German companies and often combine with other “stakeholders,” especially trade unions, to resist change. Banks also vote the stock of private shareholders at board meetings.

Erhard became Chancellor in 1963, but he was unsuccessful and resigned in 1966. The system he had established was clearly breaking down some time before his death (1977). He had only used the phrase “social market” to assuage his international advisers and was probably closer to the Ordoliberals. But he was never a party man, and he failed to impress on the Christian Democrats the lessons of a free economy. Helmut Kohl gave a laudatory speech in 1997 at the celebrations marking the 100th anniversary of Erhard’s birth. But as a free-market critic said, “He would not have understood the real doctrine of Erhard and if he did he certainly would not have agreed with it.”

The social-market thinkers have won. Germany has a vast welfare state, including an almost completely unfunded pensions system that will impoverish future generations and a regulatory and tax system that offers no incentives to anybody to invest in the country.6 Its admired consensus now is a barrier to innovation and change. We saw that in the recent economically rational hostile takeover bid by Krupp for Thyssen. The “stakeholder” groups got together and turned it into a tame merger. The first condition was that there should be no job losses. It took the huge foreign bid by Vodafone in its capture of Mannesmann to presage a relaxation of the stranglehold of “stakeholder” groups on German industry.

Perhaps the biggest mistake of both the Ordoliberals and the sensible social-market theorists was the failure to make their reforms long-lasting. Representative assemblies subject to little restraint are not going to quell the voracious appetites of pressure groups, and they always answer to electorally effective minorities. It is clear that the mass of the German people would like a change in the system. Yet it is the parties that are now cartelized, and it is in their common interest to preserve the present order. Germany has a nominal federal political system, but the central government’s capture of large areas of public policy, especially welfare, has prevented jurisdictional competition between die Lander (the component states) in the offer of rival agendas.

Erhard was effective because of the chaos caused by a world war. The benign but inefficient current economic regime will be even harder to reform, and to make an Erhardian economic system permanent will be much more difficult. One important lesson the rest of the world can draw from the German experience is that there is no “third way,” “capitalism with a human face” or market welfarism: there is either the real thing or, even for rich countries, incipient poverty.

1. For the historical background see Alan Peacock and HansWillgerodt, German Neo-Liberals and the Social Market Economy (London: Palgrave Macmillan, 1989) and Germany’s Social Market Economy: Origins and Evolution (London: Palgrave Macmillan, 1989).
2. See Norman Barry, “Political and Economic Thought of German Neo-Liberals,” in Peacock and Willgerodt, German Neo-Liberals and the Social Market Economy, pp. 105-24.
3. See Norman Barry, “The Social Market Economy,” Social Philosophy and Policy, vol. 10, 1993, pp. 1-25.
4. Ludwig von Mises, Human Action (New Haven, Conn.: Yale University Press, 1963), p. 723.
5. Norman Barry, “The Political and Economic Thought of German Neo-Liberals,” pp. 121-22.
6. Interestingly, Britain has a much less serious pension problem because it is partially privatized, but a much more critical health problem since, unlike Germany’s, it is almost completely nationalized. The two countries could learn from each other.