The Social Market Economy in Germany
For the first three years after the war, the German economy was in a chaotic state, and living conditions were worse than they had been at any time during the war. The Nazi system of economic management, including price controls and food rationing, was still in place, but there was no central authority to administer it. The country was divided into four occupied zones, and, until the merger of the British and American zones in 1947, there was little co-ordination between them. Normal market incentives were not functioning, and the currency, the Reichsmark, had lost most of its value; firms and households relied extensively on barter and the black market. The slow pace of recovery was due as much to the policies of the occupying powers as to the effects of the war. The victors insisted that Germany must be made to pay for the destruction it had caused. This was to involve reparations, in the form of plant and equipment which would be dismantled and exported to the victorious nations, and restrictions on German industrial production. The main target was heavy industry, especially coal and steel, which was to be cut back in favour of light industry and agriculture. Although extreme ideas about the ‘pastoralisation’ of the German economy were quickly dropped, these measures contributed to a general state of demoralisation in the country.
The turning-point came in 1947, when the Truman administration in the US recognised that punitive policies towards Germany were damaging the interests of the West; a prosperous and united Europe could not be achieved with a permanently weakened Germany. With the announcement of the Marshall Plan and the subsequent merger of the three Western zones, the stage was set for the creation of the Federal Republic of Germany as an independent state, firmly tied to the Western alliance.
How this state should be organised, and how relations between West Germany and its neighbours should be regulated, were far from clear at the time of the Marshall Plan. The French government was determined to prevent the resurgence of a powerful neighbour that might again threaten France’s security as it had done three times in the previous eighty years. A particular concern was the coal and steel complex in the Ruhr, which, the French argued, should be either drastically reduced in size or placed under international control. These fears were not easily reconciled with the American view that the revival of German industry was vital for the rest of Europe; unless Germany resumed its former role as the main supplier of capital goods to its Continental neighbours, Europe would be dependent for an indefinite period on American equipment and American money.
The Americans wanted to mould West Germany, and Western Europe as a whole, in their own image – an efficient, competitive, capitalist economy tempered by the reforms of Franklin Roosevelt’s New Deal.6 But they did not try to impose a detailed blueprint on a cowed West German population. It was for the Germans themselves, subject to Allied approval on key points, to design their own institutions. The outcome was a blend of Americanisation and home-grown ideas.
The Social Democratic Party (SPD), whose prestige was high because of its opposition to the Nazis, believed that capitalism had failed and that it should be replaced by planning, public ownership and ‘economic democracy’; the last had been a long-standing party objective since the 1920s – an equal share for employees and trade unions in the running of the economy and in the management of companies. The Christian Democrats, a new party which united several of the centre-right parties of the Weimar period, were opposed to socialism, but a strong faction within the party had doubts about the free market as the principal regulator of economic activity. The party’s 1947 programme, known as the Ahlen programme, declared that ‘the capitalist economic system has failed to do justice to the vital political and social interests of the German people’, and called for the public ownership of major enterprises.7 Even the Free Democrats, a union of pre-war liberal parties, took a cautious line on the restoration of free markets.
The most coherent analysis of Germany’s past history and current situation came, not from the political parties, but from a group of academics who had been pondering the flaws in the country’s political and economic system since the 1920s. One of the leading figures was Walter Eucken, who was appointed Professor of Economics at the University of Freiburg in 1927 and continued in that post throughout the war. Others such as Wilhelm Röpke and Alexander Rüstow went into exile after Hitler’s rise to power, but they remained in contact with one another during the war.
The principal lesson which this group drew from the collapse of the Weimar Republic and the disasters that followed was that a third way had to be found between unbridled laissez-faire and the collectivism that had failed so abysmally under the Nazis. At the heart of their philosophy, sometimes called Ordo-liberalism, was the need for strict safeguards against the concentration of power, whether in the hands of government or of organised interest groups. The government’s influence over the economy must be limited in scope and governed by clear rules, so that the temptation to intervene for short-term political reasons would be eliminated. An independent central bank, with a remit to resist inflation and maintain the value of the currency, was part of this rules-based framework. The conduct of fiscal and monetary policy must be consistent and predictable, with anti-cyclical measures kept to a minimum. The highest priority must be given to the promotion of competition; the prevalence of cartels and tariffs was seen as one of the principal causes of the malfunctioning of the German economy under the Weimar Republic. But the Ordo-liberals did not envisage a passive, nightwatchman state. The government had to be strong enough to ensure that the rules of the market economy were enforced. It also had responsibilities in the social field, at least to the extent of providing a safety net for the disadvantaged. The approach was nearer to classical liberalism than to the Keynesianism which became fashionable in Britain and in the US after the war. It was an attempt to redefine liberalism in a form suitable for a modern society.8
These ideas were actively promoted by Eucken and others after the war, but at that time the tide of opinion was running in favour of a planned economy in which the price mechanism would play only a limited role. When the American and British authorities set up a Bizonal Economic Administration in 1947, most of the senior posts were held by Social Democrats and trade-unionists. A mild form of socialism, as favoured by the British, seemed a likely outcome when the Germans resumed control of their affairs. But an advisory committee was established on which pro-market economists, including Eucken, were represented, and they had an important influence on the debate which preceded the currency reform in June 1948. The reform itself, which involved the introduction of a new currency, the Deutschmark, to replace the Reichsmark, was the responsibility of the occupation authorities, but the other changes which were made at the same time – above all, the removal of almost all controls over prices and wages – reflected the victory of the liberals over the dirigistes within the Economic Administration. The man who was responsible for implementing the reforms, and had a large part in shaping them, was Ludwig Erhard.
The son of a shopkeeper in Fürth, northern Bavaria, Erhard was trained as an economist at the Nuremberg School of Commerce and worked for a market research organisation from 1928 until 1942. He then set up his own research institute and from this base he developed ideas about the post-war economy which, though not directly influenced by Eucken and his colleagues, placed the same emphasis on competition and sound money.9 In 1944 he circulated a memorandum to bankers and industrialists which included proposals for a currency reform and the phased removal of government controls. Erhard was not an active opponent of the Nazis, but he had kept his distance from them, and when Fürth was liberated by the Americans in April 1945, he was asked to take charge of economic administration in the area. Later in 1945 he was appointed to the post of economics minister in the new Bavarian government. Although Erhard fell out with other members of the administration and resigned in January 1947, he continued to propagate his views, and in September of that year he was invited to head a committee on currency reform within the Bizonal Economic Administration. A few months later the director of the Administration, Johannes Semler, was removed from office after making critical remarks about the policies of the occupying powers, and Erhard was appointed to take his place.
The 1948 reforms were spectacularly successful. ‘On the morning after the introduction of the Deutschmark, people accepted money in exchange for goods and labour services, the shop windows were full of goods which had previously been unavailable –