Anatomy of a giant

The German Economy - Money and Magic
January 27, 1995

After the turmoil of reunification, many informed commentators thought that it would take the rest of the decade for Germany to resume its dominant economic position, and to provide the locomotive for European economic growth. Yet despite very high labour costs, the terms of internal monetary union and the higher exchange rate consequent upon the collapse of the exchange rate mechanism, and despite the burden of financing the new eastern Lander, Germany appears to have resurfaced. Strong export growth has pushed the overall economic growth rate up towards 3 per cent, and inflation has been brought back under control. Another economic miracle has occurred.

Such an achievement would be unimaginable in Britain. To absorb an industrial wasteland like East Germany, to finance this through higher tax, to increase exports against a rising exchange rate, has proved beyond Britain's capacity except in times of war. Britain's current economic growth spurt (at over 3 per cent) has been achieved on the basis of a major devaluation of sterling, and an injection of public expenditure on a massive scale of which only extreme unreconstructed Keynes- ians dreamt in the 1970s and 1980s.

How has Germany done it? What is the secret of its success? This question has baffled conventional economists time and time again in the postwar period.

To Anglo-American economists, the Germans do all the wrong things: they protect their companies from hostile takeovers; they cosset their workers with generous social security provisions; they allowed workers to have a say in business long before the social chapter was enacted in the Maastricht Treaty; they face heavy taxation; monopolies dominate important sectors of the economy; and the role of local and national government is extensive. To many economists of a Thatcher-Reagan persuasion, and to many of their counterparts published by economic think tanks like the Institute of Economic Affairs and the Adam Smith Institute, the German economy should, in theory, be a disaster.

Part of the answer is provided in Eric Owen Smith's excellent book, The German Economy. Smith takes his readers through a textbook treatment of each of the major aspects of the postwar German economy. This treatment has the advantage of providing the student with a clear and concise reference. The book abounds with facts and statistics essential to an understanding of the evolution of the early recovery and then rapid expansion of the economy. In the English language, it is probably the best single reference available.

The temptation to browse selectively that textbooks typically hold out to readers is to be resisted in this case. The sum of the chapters is much less than the whole. For Smith's account brings out a number of clear themes which go to the heart of our question. He carefully shows that the German social market is a coherent whole into which each of the bits fit -- social policy, competition policy and so on. It cannot be dissected into parts, a lesson of great importance to current German liberals on the right who would like Germany to be subjected to a dose of Thatcherism.

The careful empirical approach of Smith contrasts with the broad literary tack taken by Hans Christoph Binswanger in Money and Magic: A Critique of the Modern Economy in the Light of Goethe's Faust. Binswanger's target is much broader than the German economy. He has in his sights the process of economic development since the industrial revolution, and makes the claim that Goethe foresaw a process by which mankind would try magically to transform natural resources into greater and greater amounts of money. This Binswanger regards as alchemy. The creation of money is "the master key that grants access to all the treasures of the world".

The book provides a careful analysis of Faust in the attempt to establish the role of Goethe as prophet, and no doubt it will excite controversy among literature specialists. To an economist, however, it remains unconvincing. The process of wealth creation is not alchemy: it is a well-researched process. We may not fully understand why some economies, like Germany's, do much better than others, like Britain's. The differences may well be explained in part by cultural factors. But the answer to the question -- why Germany has succeeded ? -- is more likely to be found through the kind of empirical research represented by Smith's text than by examining Goethe's predictions.

Binswanger would have us conclude from Faust that we need carefully to conserve our natural resources, and not to be blinded by the process of money creation into neglecting the costs of economic growth. The exhortation is clearly a sensible one, as can readily be seen by examining the mess left by the communists in East Germany. But whether our delusion stems from fundamental faults in human nature, or whether it stems from inappropriate policies which have failed to protect the environment, is an open question. We can however try to do something about the latter. The former is a much harder nut to crack.

Dieter Helm is a fellow of New College, Oxford.

The German Economy

Author - Eric Owen Smith
ISBN - 0415 06288 8 and 06289 6
Publisher - Routledge
Price - £75.00 and £19.99
Pages - 592pp

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