Reflections on the German economy. A macroeconomic approach. Part 5: A Keynesian – Neoclassical synthesis.

By Egon Neuthinger

 

1. Introduction

 

The present state of the art of economic policy and its underlying theoretical bases are a unique one. It is the result of a long and tiresome struggle. The market orientation of economic policy was never as distinct and clear as today. There is a good deal of laissez-faire legacy in the actual policy approach, which is for example manifest in the idea to build a “market conform democracy.” It has not always been like this. For a much longer time, the idea of a more “activist and interventionist” Keynesian policy stance prevailed.

Every economic system or economic order should have a fundament, a set of principles which guides all else. In Germany, this was the ORDO-idea which doubtless still is the dominating vision of the German economic order. ORDO means order, an economy must have as its basis a fundamental framework (‘Rahmenbedingung’) in which economic processes are imbedded. The leading principle of the economic process is competition (including the division of labour) among enterprises and corporations. The main task of the economic order is to secure that competition can actually take place. It is the role of the state, i.e. of economic policy, to establish rules, institutions and the legal environment in such a way that competition can be realized. The ORDO-conception was the radical answer to the so-called paleo (old)-liberalism or laissez-faire liberalism and the “non-system” of the interwar years of the thirties. The ORDO ideas were directed against the legacy of cartels, monopolies, oligopolies and interventionist practices which had made a caricature of a competitive economy. The ORDO-people saw themselves as the “Neo-Liberals” in order to distinguish themselves from the older laissez-faire capitalism. The ORDO- liberals or Neoliberals have thus to be distinguished from the present day meaning of neoliberals.

2. The social market economy approach versus the ORDO-liberals

The ORDO-Liberals (such as Eucken, Röpke, Rüstow, Lampert, Micksch and Müller-Armack) all shared a repudiation of laissez-faire competition, but they represented different views to other issues of economic policy. The more common and known conception of the Social Market Economy is inseparably  interwoven with the name of Müller-Armack, although other ORDO-theorists, such a Eucken and even Erhard did not agree. The label “Social Market Economy” should according to its founders – especially Müller-Armack – supplement the market system with a framework of institutionalized social assistances ( i.e. pensions, unemployment, people with hardships etc.) to protect people against markets and failures, for instance cyclical downswings or personal reasons. To note is that the strict market economist Hayek voted against such social helps; according to him an economy with the epitheton “social” is not a market economy.

A second issue that divided the ORDO-theoreticians was business-cycle or anticyclical policy. The initiator of the Social Market Economy, Müller-Armack, who was for many years the Secretary of State in the Federal Ministry for Economics and some other ORDO-economists, advocated already in the fifties for an active business cycle policy. This view was not shared by all ORDO-Liberals, especially not by one of the leading economists, Walter Eucken. It might be noteworthy, that this subject is still being debated even today.

The ORDO-or neoliberal preposition is thus the vision of an economy as an organism which is conceived by the idea of a framework (Rahmenbedingungen) set by policy-makers which shall secure competition in all markets. Competition (added by division of labour) is proclaimed as the main mechanism for success in a market economy. Such an economy requires a functioning price mechanism, which is vital for an efficient allocation of resources. But allocation does not mean growth. It is for this reason that the Council of Economic Experts accentuated dynamic competition in the eighties.

Markets are viewed as institutions that continuously detect new possibilities for innovations in products and technology and for producing with the least costs and the highest productivity – a Schumpetarian and neo-Austrian thought (cf. Hayek’s thesis of “discovery processes”). The view of the ORDO-Liberals was one of true and pure competition where entrepreneurs and enterprises compete with one another on free markets. The ORDO-theoreticians abhorred therefore monopolies, oligopolies and any other market dominating enterprises as well as price and product agreements between businesses and so forth. In short, what these economists had in mind was ‘fair competition.’

German economic policy in the fifties was highly influenced by these ORDO ideas. It was the time of the “Competition Laws” – a series of laws that forbade restrictions on competition and enterprises that were capable of dominating the market. These policy measures, which had been formulated by the Ministry for Economics, have without doubt been positive for the function of the German economy. They were in line with the concept of the above outlined Social Market Economy, the content of which was a social cushioning for people and families who were in need of public relief. A reasonable redistribution of income was therefore an ingredient of the political philosophy.

But the ORDO-Liberals were against a welfare state. As already mentioned, some ORDO-Liberals were indeed interested in business cycle policies, but the topic remained unsettled. The ORDO-liberals strongly believed that market transactions led to optimal results and looked with a lot of skepticism towards any state intervention.

These ideological beliefs influence the formulation of economic policy in Germany until the present day: market solutions are, in the last analysis, always preferred to state interventions. This is especially clear regarding today’s reluctance to engage in macroeconomic state actions. This state of mind naturally influences important domains of policy, especially fiscal and budgetary policy. On theoretical grounds, the orientation is also manifest in the reluctance to analyze economic events in the framework of macroeconomic interdependences. Last but not  least: the “market-orientation –thesis rests on the assertion that the free working of the markets by microeconomic actions and the coordination of economic activities leads to optimal results for the society as a whole.

It would be very interesting to assess the present state of the German economy and German economic policy from the perspective of the ORDO-Neoliberals of the fifties (including the proponents of the Social Market Economy) in order to see how much the present policy-stance matches the ideas of the ORDO-theoretician. In fact, the ORDO-view is often referred to as the centre of the German economy policy. Until now, such analysis has not been undertaken, but it is clear that present economic policy structure would most probably not match the ORDO-views.

3. The ORDO-liberals and neoclassical and monetarist economics

Some remarks about the relation between the ORDO-liberals and neoclassical/monetarist economics are in order. Both schools favor market solutions and are adverse to state actions and interventions. The dominant neoclassical/ monetarist paradigm is the “stability of the private sector”, i.e. the inner drive and capacity of market forces to stabilize the economy and its structures and to attain equilibrium. ORDO liberals would have agreed with that, provided there is true competition. However, neoclassical/monetarist theory moved much further with Monetarism Mark II, i.e. the Rational Expectation Hypothesis (REH) which postulates that individual economic agents know the true economic model by experience and act accordingly so that optimal economic processes emerge; state actions are therefore not only not necessary but inimical; the REH-school is against and forsakes stabilization policies. ORDO liberals would probably be skeptical about this RE-hypothesis. Also the thesis of efficient and deregulated (financial) markets and the strongly neoclassical influenced deregulation agenda would not have found (much) agreement. ORDO liberals would also be critical of the present structures of the market economies (giant concerns, multinationals and their influence on policies, even increasing corruption, the prevailing tax structures and tax evasion, income distribution and other ailments). They would thus also not agree with the influence and power of the financial and corporate sector on economic policy.

4. A Keynesian – Neoclassical synthesis?

In connection with the conceptions of a market based economic policy that we just outlined, some important ingredients were established in the eighties, namely the so-called three big C’s: Credibility, Continuity and Consistency.

The basis of these criteria is the longer or medium term orientation of economic policy in contrast to short-termism. Economic policy should act according to a rule-based framework; it should follow a credible and continuous policy stance and should, in doing so, gain a credible reputation and confidence and create positive expectations for private agents. The constancy postulate of economic policy was in the fifties also accentuated by the ORDO-Liberal Walter Eucken. Confidence and credibility is also an often-mentioned postulate for present economic policy: balanced budgets, no tax increases, steady medium term public expenditures etc. In commenting upon this framework, one should however keep in mind that a policy must most of all be consistent with the surrounding economic conditions

For some 1 ½ decades German economic history and policy were characterized by a more Keynesian approach .Already in the fifties, the Scientific Councils at the Ministries of Economics and Finance had outlined the framework of demand policies. In the Social Democratic Party and the Trade Unions, Keynesian oriented economists had outlined principles of economic planning as well as for systematic business cycle policies, but these conceptions found not much resonance in actual policy. It was during the sixties, with their inflationary appearances and the budgetary and economic crises of the mid-sixties, which led to the first Great Coalition. The new Minister of Economics, Karl Schiller and his Secretary of State Klaus-Dieter- Arndt became the architects of the Keynesian oriented economic policy design. Aggregate demand became one of the cornerstones of economic policy. Schiller and Arndt were the main actors behind the Law on the Promotion of Stability and Growth of the Economy of 1967. The law aimed at reasonable price stability, a high degree of employment, adequate and steady economic growth and, especially important given the context of our paper, a balanced current account.

Schiller and Arndt judged high current account surpluses as an economic imbalance on account of their potential inflationary consequences. There was another, more important reason: both economists aimed at a higher internal demand and not the least also for international reasons. Thus in the annual economic reports of the Government at the end of the sixties and in the seventies a net export surplus and a current account balance of 1% of GDP was an important target.

Do not forget: this law of 1967 is still in force. The law remained relevant for the policy agenda of the seventies but was then gradually discarded with the so-called “political turn-around” (Politische Wende) at the beginning of the eighties.

A second step of the new policy conception was the establishment of “Concerted Action.“ Behind this amendment stood Tinbergen’s idea of economic policy as a common task of all three main actors, of the state, the trade unions and employers associations and the monetary authorities. The Bundesbank took thereby part at the meetings but made clear that it felt not bound to the decisions and policy proposals of the concerted action. The concept of the Concerted Action should also be understood as reflex of the vision of a society in which the common welfare (Gemeinwohl) is the ultimate guidance for economic policy. It is needless to say that the Concerted Action tool was another expression of a cooperative policy solution of a Keynesian Social Democratic Consensus. There was however only a limited success ; this institution held as long as there existed true common policy interests. Thus the concept had the same fate as aggregate demand policy. There was a lack of insight in the long run benefits of such a policy design. Or one could say that the time for such visions was not ripe.

In this context in the sixties and seventies there were intensive and fruitful discussions in Germany about process and ORDO-policy. The so-called Process policy was understood as demand management policy, as state action to avoid (deep) recessions and booms, i.e. a policy of fine tuning was thought necessary. The concept of process policy had gained momentum with the reception of Keynesian thoughts; it was intellectually prepared by the Scientific Councils of the Ministry of Economics and Finance and other Keynesian oriented economists already in the fifties, but only gained weight at the end of the sixties, especially pronounced by Schiller and Arndt. From the end of the sixties to the end of the seventies the experiment of process policy was tried; it could however never been exercised system oriented, because market constellations and – conditions but also political hindrances stood against it. Thus in the seventies inflation dangers were high, partly because necessary revalorizations at the end of the sixties were not taken early enough and then too timid; later strong inflationary effects of two oil price hikes and increased wage and income inflation dominated and evoked strong inflation.

It was only logical to complete the Schiller story that in the decades after World War II and especially in the sixties and seventies there were strong deliberations to bring the two basic approaches – the ORDO and Keynesian designs- together, again led by the thrust of arguments of the Minister for Economics Schiller with the slogan of the “symbiosis of the Freiburger Imperative and the Keynesian message.” The University of Freiburg was viewed as the nucleus of the ORDO movement. Schiller based his postulate on the theoretical concept of the so-called “neoclassical synthesis” as was derived by the economists John Hicks and Paul Samuelson who developed theorems that aimed to somehow synchronize neoclassicism and Keynesian economics. Schiller translated this theoretical considerations into practical policy. Market solutions as far as possible, planning as far as necessary. Market solutions referred to the microeconomic neoclassical and the planning part to the macroeconomic Keynesian view. The neoclassical synthesis was and is today however strongly questioned as the original Keynesian view. But in debates about practical macroeconomic policy concepts the Schiller/Arndt approach is at present the promising alternative concept to the market approach.