The German Economic Miracle and the "Social Market Economy"
There is No Third Option between Government Control and Free Markets
APRIL 01, 2008 by RICHARD EBELING
Richard Ebeling is the president of FEE.
This summer marks the 60th anniversary of the beginning of the post-World War II German “economic miracle.” When the war ended in Europe in 1945, Germany was in a shambles. Its major cities had been destroyed either from Allied bombing or urban combat. Millions of its citizens had died in the war, and millions more were turned into empty-handed refugees. Food was almost nonexistent, and starvation gripped most of the population.
The Nazis had imposed a comprehensive system of economic controls on prices, wages, and production. They had turned to the printing press to finance a good part of the costs of war, resulting in a “repressed inflation” under the stranglehold of the price regulations. The increasingly scarce goods were rationed or simply disappeared from the stores. By the time Germany surrendered in May 1945, the National Socialist version of the planned economy, and above all the war, had brought Germany to a state of social and economic collapse.
Now the country was under the joint occupation of the four Allied Great Powers: the United States, Soviet Union, Great Britain, and France.
In the Soviet zone, factories not destroyed in the war were dismantled and shipped back to the Soviet Union. Soviet soldiers terrorized the population, and Stalin proceeded to impose a communist political structure.
In the American and British zones Soviet-style brutality was rarely practiced, but the German population was viewed as “the enemy” to whom excessive sympathy and generosity were not to be shown. Moreover, the Nazi system of price and production controls was kept in place.
A small band of German free-market advocates had survived the war. A leading figure in this group was Walter Eucken, who was a professor at the University of Freiberg. While restricted in what they could say publicly under the Nazi regime, Eucken and his colleagues had maintained a network among themselves with the goal of sharing ideas for establishing a market-oriented economy in the post-Hitler era that they all impatiently awaited. While intellectually isolated from other free-market economists outside Germany, they remained inspired in their thinking by classical liberals like Ludwig von Mises and Wilhelm Röpke, whose writings they read and clandestinely shared.
One of Eucken’s protégés was an economist named Ludwig Erhard. He was appointed economics minister in the American zone in Bavaria in 1946. For two years he used this position as a platform to advocate market reforms. In radio broadcasts he frequently exhorted the German people to accept that they had brought their current tragic circumstances on themselves and only hard work, savings, and self-responsibility could restore their prosperity and gain them a new place among the civilized nations of the world.
In 1948 the British and American zones were combined into one administrative unit, with Erhard as director of economics. In June he instituted a major currency reform to restore monetary stability and to end the inflationary after-effects from the Nazi period. Not only was a new currency put in place, but it was done through a process of reducing the money supply. In June 1948 Germans in the Western zone could exchange ten of the old marks for one new mark.
Shortly after this, Erhard introduced the other essential element of any successful economic-reform project: abolition of the price and production controls. On a Sunday, while all the Allied occupation authorities were out of their offices, Erhard announced on the radio that the next morning virtually all price controls would be abolished. General Lucius Clay, commander of American forces in Germany, called Erhard into his office and said, “Herr Erhard, my advisers tell me you’re making a terrible mistake.” Erhard replied, “Don’t listen to them, General. My advisers tell me the same thing.”
Hoarded goods in short supply suddenly came out of their hiding places now that they could be sold at market-based prices. In the second half of 1948 industrial production increased 46 percent from its June level. And a year later, at the end of 1949, that production was 81 percent above what it had been when the reforms had been implemented in the middle of 1948. After an initial spike in prices when the controls were abolished, by the end of 1950 the greater industrial and agricultural output that was offered on a more open market significantly reduced the cost of living. Germany’s economic-recovery path assured that well into the 1960s its rate of growth in output and productivity would place it far ahead of virtually all the other countries of western Europe, including those, like Great Britain, that had been victors in the war.
The reforms brought about this economic miracle because they eliminated the worst institutional features of what had been Nazi central planning. But West Germany was not transformed into a real free-market society. Its intellectual architects, including Walter Eucken, Wilhelm Röpke, and Ludwig Erhard were advocates of a “middle way” between a truly free market and socialist planning. They believed that a large welfare state, the “social market economy,” was necessary and desirable to assure social harmony. They supported government regulation of the size and composition of large enterprises. They supported urban and rural planning. And they introduced the system of “co-determination,” under which all large enterprises and corporations were legally required to have trade-union representatives included in the decision-making bodies of businesses.
Thus from the start the institutional order in postwar Germany was one that opened the door to special-interest-group politics, compulsory income redistribution, union-power blackmail over business, and a general culture of political paternalism.
The real nature of this system was insightfully explained by Mises:
[T]he supporters of the most recent variety of interventionism, the German “soziale Marktwirtschaft” [social market economy], stress that they consider the market economy to be the best possible and most desirable system of society’s economic organization. . . . [But] it is necessary, they say, that the state interfere with the market phenomena whenever and wherever the “free play of the economic forces” results in conditions that appear as “socially” undesirable. . . . If it is in the jurisdiction of the government to decide whether or not definite conditions of the economy justify its intervention, no sphere of operation is left to the market. . . .That means the market is free as long as it does precisely what the government wants it to do.
Sixty years after these German reformers introduced the “social market economy,” it is clear that they were only planting the seeds of new forms of government control and corruption. The market is either free or it is under the regulation of the government. Either individuals are free persons who may peacefully go about their lives and associate with others through voluntary exchange, or they are pawns on a political chessboard, open to manipulation and control whenever their actions do not follow what those in power demand.
There is no third way.