Wednesday, December 19, 2012

The Myth of Ludwig Erhard and Economic Policy in Germany in 1948

There is a myth that has grown up around Ludwig Erhard and his abolition of price controls in Germany in 1948.

That mythology is illustrated well in this section of the Commanding Heights documentary below.

First, nobody denies that Germany experienced economic chaos after 1945. The war devastated the economy. The destruction of so much of Germany’s capital stock and its severe supply problems obviously meant that special economic polices were required. Demand-led Keynesian stimulus was obviously the wrong policy in the immediate post-1945 period.

Nevertheless, let us review the myths and problems with this video:
(1) This video creates the myth that in 1948 the German economy was suddenly and completely liberalised. Nothing could be further from the truth. The West German economic miracle in the 1940s and 1950s occurred with a high degree of government intervention.

(2) We are told that Ludwig Erhard decided to abolish “all price controls.” That is simply not true. Ludwig Erhard’s abolition of price controls was hardly complete. The “Law of Guiding Principles” that outlined Erhard’s reform reveals a very different program from the myth created in this documentary. For example,
(1) food and raw materials remained under control;

(2) textiles, clothes, shoes and soap continued to be rationed, and

(3) prices for staple foods, raw materials, and rents were also still subject to regulation. (Mierzejewski 2004: 71).
(3) There is no doubt that moderate liberalisation of prices eliminated the black market in many goods. But the speed with which goods “reappeared” is exaggerated in the documentary; it did not happen “overnight.” In fact, it took weeks for goods to reappear in serious quantities (Mierzejewski 2004: 72), and one consequence of the reform was that unemployment rose (Mierzejewski 2004: 72).

Arguably, three other factors did far more for the German economic recovery from 1948. First, the currency reform of 1948 and the introduction of the new Deutsche Mark (on 20 June 1948) was an important step, since the old Reichsmark was near worthless.

Secondly, the industrial and economic problems in Germany were partly caused by the “industrial disarmament program” pursued by the Allies from 1945 that involved actual removal of capital goods equipment and an import embargo on raw materials. The abandonment of that policy was a major step in the economic recovery.

Thirdly, the Marshall aid program did more to provide consumer goods in Germany after 1945 than the liberalisation of price controls. Germany’s import needs were greatly depend on Marshall aid: 70% of imports in 1946–1947, 65% in 1948 and 43% in 1949 (Hitchcock 2010: 164). When the recovery of 1948 caused a balance of payments crisis, Marshall aid covered the deficit.

Also, government earnings from the sale of Marshall aid goods were used by the government to finance public investments in electricity, coal mining, agriculture, housing, railways and shipping (Hitchcock 2010: 164).

(4) The soaring inflation and difficulty many people had in obtaining basic consumer goods caused what can only be described as a volte face by Erhard.

By September 1948, Erhard oversaw an intervention called the “Everyman Program” designed to control the inflation unleashed by his liberalisation. In this program, raw materials were directly allocated to producers of consumer goods, so that these businesses would charge prices deemed fair by the government. The public had access to consumer goods such as clothing, shoes, and kitchen utensils at prices well below what were being charged on unregulated markets, and the type of goods subject to control varied as circumstances dictated (Mierzejewski 2004: 75). That program did not end until 1951.

(5) Erhard happily accepted Marshall aid which, crucially, overcame the balance of payments constraint in post-WWII Germany and provided the imports of consumer goods and capital goods that the Germans badly needed given their crippled economy (Mierzejewski 2004: 76). Needless to say, Marshall aid was hardly a “free market” policy.

(6) Also, much is made in this documentary of the fact that the German economy overtook that of the UK in the post-war period, as if this had to do with Germany’s alleged laissez faire policies. In fact, Germany, had always been the largest economy in Europe from the early 20th century, and its return to that position by post-1945 economic growth was nothing but the natural consequence of its reconstruction and the recovery of its export-led growth sector.

(7) Another paradox is that it was Ludwig Erhard who popularised the term “social market economy,” the term that described the West German mixed economy after 1945. Mises spits bile at West Germany’s “social market economy,” and regarded it as just another interventionist state that would allegedly lead to totalitarian socialism. One wonders how Austrians could seriously point to West Germany as an example of their brand of economics.

(8) One final statement in the documentary is that after 1945 “most countries preferred to plan their economies” (in contrast to West Germany), a gross exaggeration. West Germany had the same fundamental mixed economy as most other Western nations. The mixed economies in the capitalist West – even those with some nationalised industries – were hardly “planned economies,” for that phrase, if it is to have any meaning, must refer to communist command economies.
What about other aspects of West German economy policy after 1948?

Although the West German government practised fiscal restraint in the 1950s, the mass destruction of so much of Germany’s capital stock allowed good returns from investment in capital for many years, and the growth of the post-war era was a function of reconstruction. Germany required a great deal of reconstruction, much greater than, say, the United States and even the UK.

Germany policies in the 1950s essentially drove the economy back to its export-led growth model, though one consequence was that Germany suffered a serious problem of unemployment in the 1950s: unemployment was shockingly high at the beginning of this decade and only gradually fell from about 10% to 3% during the course of the decade. At the same time, the 1950s saw a great expansion of the welfare state in West Germany, and social outlays provided automatic stabilisers to some degree.

But the economy was hardly an example of a free market paradise. Even in the 1950s, a vast swathe of German industry was still owned by the government: about 40% of coal and steel, 66% of electricity production, 75% of aluminium and most German banks. For example, Volkswagen was owned by the West German state until 1961 when the government sold its majority stake in the company (a move which was part of a privatisation program by Konrad Adenauer that had begun in 1957). The German government also prevented foreigners from taking over German automakers.

By the mid-1960s, the post-war boom ended, and German governments turned to overt Keynesian policies to stimulate demand.

In general, though I have not read these German works, Berger (1997) and Nützenadel (2005) detail how there was a great deal of macroeconomic management of the West German economy by the government from the early 1950s.

Allen, Christopher. 1989. “The Underdevelopment of Keynesianism in the Federal Republic of Germany,” in Peter Hall (ed.), The Political Power of Economic Ideas: Keynesianism Across Nations. Princeton University Press, Princeton. 263–289.

Berger, Helge. 1997. Konjunkturpolitik im Wirtschaftswunder : Handlungsspielräume und Verhaltensmuster von Bundesbank und Regierung in den 1950er Jahren. Mohr Siebeck, Tübingen.

Hitchcock, W. I. 2010. “The Marshall Plan and the Creation of the West,” in Melvyn P. Leffler and Odd Arne Westad (eds.). The Cambridge History of the Cold War. Volume I. Origins. Cambridge University Press, Cambridge. 154–174.

Mierzejewski, Alfred C. 2004. Ludwig Erhard: A Biography. University of North Carolina Press, Chapel Hill, N.C. and London.

Nützenadel, Alexander. 2005. Stunde der Ökonomen: Wissenschaft, Politik und Expertenkultur in der Bundesrepublik 1949–1974. Vandenhoeck & Ruprecht, Göttingen.


  1. The Commanding Heights is propaganda of the worst kind: it has the appearance of honesty. But it's distortions are too many to count. The feature that irritated me most is the unstated assumption that there is no difference between Keynesian macroeconomic policy and Marxist central planning.

    The statement from some Bush White House loser that Carter was "the most Keynesian" president is also infuriating. The seven presidents who preceded Carter were all much more Keynesian than he was!

  2. The nice thing about freedom and free markets is that it takes just a little to make a big difference to the wealth of the population. Given all the controls of a German society just a tiny loosening allowed a country living in the Stone Age to recover. I wonder how much economic aid East Germany received from the USSR? Seems like there was also some dismantling of factories going on at the time US aid was coming in. I'm sure foreign aid was as effective in West Germany as it is today in so many developing nations receiving it. I guess West Germany was really no better-off than East Germany except for all the foreign aid and price controls. It really is hard to tell what made a difference in the two economies?

    1. "I wonder how much economic aid East Germany received from the USSR?"

      I'll satisfy your curiosity. In fact, the USSR exacted punitive war reparations from East Germany. This included payments for years after the war, but another aspect was Soviet seizure and removal of industrial infrastructure. So, yes, perfect testing conditions.

  3. Right. And without the Korean war boom Germany could hardly recover from the early 1950s balance of payment crisis (that led her to borrow from her European partners! and later Germany benefited of the debt restructuring that Syriza is now asking for Greece)
    The policy pursued by Germany since the early 1950's has been described by a leading German economic historian as "monetary mercantilism": let the others to be keynesian, take advantage of fixed exchange rates, control wages and domestic demand through an "independent" central bank. Erhard was behind this. I do not speak German, unfortunately, but I tried to sum up what I undestood in this regard in this paper that appeared in the Int J of Pol Ec

  4. Marshall Plan meant that for geopolitical reasons the US lifted West German BOP constraint. This is a typical case of what Serrano and Medeiros call "development by invitation."

    1. Yes, the same phenomenon was seen in South Korea, Taiwan and Japan after 1945 - and was a key factor that led to their rise as industrial giants, though not by Marshall aid, but by means of allowing them access to US markets and technologies.

  5. "The mixed economies in the capitalist West – even those with some nationalised industries – were hardly “planned economies,” for that phrase, if it is to have any meaning, must refer to communist command economies."

    I wouldn't be as confident on that front. There was substantial planning going on in, for example, France in the post-war era:

    I think that its pretty fair to call his economic planning. No, its not a command economy, but it is quite self-consciously planning.

    But yes, that documentary does appear to be naked propaganda. I like when Friedman says that "wage and price controls never control inflation", as if they hadn't worked remarkably during the war era for all countries and during the Hitler rearmament era prior to war:

  6. LK: Not related to this post, but if you are so inclined, you might be able to contribute to this. I dunno if you have any criticisms of markets internal to marginalism fresh on your mind. Seems like a tricky thing.