San José State University
Department of Economics
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The Industrial Revolution of Germany

The Industrial Revolution began about a century later in Germany than it did in England. Germany did not exist as a political unit until the latter part of the nineteenth century. First came the Zollverein (Toll Union) in 1833 that, by abolishing tolls between the various German principalities, made Germany into a common market. For a period of decades, until about 1860's, there were attempts at imitating in Germany the industrialization that had taken place elsewhere in Europe. This imitation was only moderately successful. In 1870 the modern German nation was created and thereafter major industries were founded that led to the full fledged industrialization of Germany.

The southern side of the Rhine Valley of Germany was incorporated into France by Napoleon. At that time France was, despite its economic shortcomings with respect to England and Belgium, quite a bit more advanced than Germany. This period of forced integration with France stimulated economic change in the Rhine Valley. In 1815 this area became independent of France but retained some of the economic and institutional reforms of the Napoleonic period. Serfdom and the guilds were abolished. Other remnants of fedualism were ended which restricted commerce and industry.

Prussia initiated the concept of a common market in 1818 and in 1833 a treaty extended the Zollverein to the larger states of Germany, although Austria, by Prussian design was excluded.

A rail system for Germany developed rapidly under the promotion of the German state governments. The rail system increased the demand for steel and coal. The coalfields in the Ruhr Valley were fully developed and made Germany into the foremost coal producer in Europe. A steel industry also developed and the stimulus of the coal and steel development expanded the banking and capital markets available to Germany. This helped other industries such as the chemical and electrical industries develop in the latter part of the nineteenth century. The German chemical industry became the most advanced in the world.

The Weimar Republic of Germany

The German Imperial government made many errors of judgment in connection with World War I. It first assumed that there would be a limited war between the Austro-Hungarian Empire and Serbia. When the Russian Empire decided to support Serbia the situation changed completely. The German Empire decided to support its Austro-Hungarian ally. But it knewn that France was committed by treaty to support Russia so Germany aiding Austria-Hungary would put it at war with France. Germany thought it could win by quickly striking France through an invasion across Belgium. A quick defeat of France would enable it to later deal with the gargantuan but lethargic Russian army. But in the west the war turned into four years of soul-searing trench warfare. Eventually the Russian army collapsed in the east while the western front held firm.

The German government, expecting a short, victorious war, did not make provision for covering the cost. It borrowed funds instead of raising taxes because it thought it would be able to impose the cost of the war on the losers as reparation payments.

Even with the Russian Army taken out of the war and German forces concentrated on the west the western front not only held against German offensives but the Allied counteroffensives pushed German forces back. The Gernan general, Ludendorf, recommended that Germany seek peace. Popular uprisings and a mutiny in the navy made ending the war critical. It appeared that a revolution within Germany was breaking out. The Kaiser abdicated and a Republic was proclaimed.

By 1918 there was general disillusionment with the conduct of the war and it showed up in terms of the political composition of the national legislature, the National Assembly. In the election of January 1919 the composition of the vote was as follows:

Composition of the Vote
for the National Assembly
in Germany in January 1919
Political PartyAcronymOrientationProportion
of Vote
Social Democratic Party of GermanySPDSocialist38%
German Democratic PartyDDPSocialist38%
Center PartyDDPCentrist
German National People's PartyDNVPConservative Nationalist10%
German People's PartyDVPConservative Nationalist
Independent Social Democratic
Party of Germany
Other Parties  6%

The vote reflected a general support for armistice and for socialism for the peace-time economy. It also reflected a polarization with 10 percent or more of the vote for strongly nationalistic conservative parties.

If the advocates of peace in Germany expected some leniency in the terms of peace on the basis that Germany sued for peace without being actually militarily defeated then they were sorely disappointed because the Allied Powers imposed draconian terms. The Treaty of Versailles signed in June of 1919 called for:

The name Weimar Republic comes from the name of the city in which the constitution was formulated.

Germany experienced hyperinflation in 1923 and chronic high unemployment throughout the 1920's as a result of the inability of the governemtn to cope with the problems of Germany effectively. When the unemployment rate jumped in 1930 as a result of the onset of the Great Depression the support for the Weimar Republic drained away.

(To be continued.)

National Socialist Germany

Walter Eucken was a professor of economics at the University of Freiburg, Germany and an architect of the economic reforms that led to the Economic Miracle. In this article Eucken wanted to explain the problems and weaknesses of centrally administered economies such as that of National Socialist (Nazi) Germany and the Soviet Union.

The Nazi economic system developed unintentionally. The initial objective in 1932-33 of its economic policy was just to reduce the high unemployment associated with the Great Depression. This involved public works, expansion of credit, easy monetary policy and manipulation of exchange rates. Generally Centrally Administered Economies (CAE's) have little trouble eliminating unemployment because they can create large public works projects and people are put to work regardless of whether or not their productivity exceeds their wage cost. Nazi Germany was successful in solving the unemployment problem, but after a few years the expansion of the money supply was threatening to create inflation.

The Nazi Government reacted to the threat of inflation by declaring a general price freeze in 1936. From that action the Nazi Government was driven to expand the role of the government in directing the economy and reducing the role played by market forces. Although private property was not nationalized, its use was more and more determined by the government rather than the owners.

Eucken uses the case of the leather industry. An individual leather factory produces at the direction of the Leather Control Office. This Control Office arranged for the factory to get the hides and other supplies it needed to produce leather. The output of leather was disposed of according to the dictates of the Leather Control Office. The Control Offices set their directives through a process involving four stages:

In practice the authorities of the control offices often intervened and there was continual negotiation and political battles as the users of products tried to use political influence to improve their allocations. The prices of 1936 made little economic sense, particularly after Germany was at war. So there economic calculations using the official prices were meaningless. In particular, the profitability of a product was of no significance in determining whether it should be produced or not. Losses did not result in a factory ceasing production; the control offices made sure that it got the raw materials and that the workers got rations of necessities.

At the beginning of the war the Government established a priorities list for allocating scarse resources. Activities associated with the war got top priority and consumer goods production was near the bottom of the list. If two users wanted gasoline any available stocks went to the user with the highest priority. This seems reasonable but, in fact, it led to major problems. Suppose one use of gasoline is for trucks to haul raw materials to factories. If the Government always gives the available gasoline to the Army then the truckers cannot deliver supplies to the factories and they shut down and eventually other factories dependent upon them also shut down. At first the Government tried to handle the problem by revising the priorities list and moving up uses such as gasoline for trucks. But whatever uses got put at the bottom eventually created bottlenecks. In the middle of the war the Government abolished the priority list. It was an unworkable system.

The problem with making production decisions without reference to relevant prices is that the control offices may dictate the production of goods which are of less value to the economy than the opportunity costs of the resources that go into their production.

Because of the mistakes and failures of Centrally Administered Economies there are often black markets operating. Although the authorities typically persecute people for dealing in these markets the reality is that such markets are essential for preventing a collapse of the Centrally Administered Economy.

Production decisions may be made on political criteria that are economically foolish, such as locating a factory in a region to benefit the supporters of some political figure. Even aside from such corruption of the decision process the centrally administered economy suffers from major weaknesses. The centrally administered economy can mobilize resourts quickly for big investment projects but there is no guarantee that there will be a balance of investments. For example, there may be big programs to build railroads but not enough trains to make use of those railroads.

Although Centrally Administered Economies may appear to be efficient and effective initially their errors and inefficiencies accumulate and eventually result in stagnation if not collapse. Often the apparent successes of such economies are just illusions. Outsiders who do not know how such economies really work are often fooled by these illusions.

Centrally Administered Economies (CAE's)

  • I. Strengths
    • A. Can easily eliminate unemployment with large investment projects. This is because a CAE does not consider whether the benefits of investment projects exceed their costs.
    • B. Resources can be mobilized quickly.
  • II. Weaknesses
    • A. Decisions are often made on noneconomic basis
    • B. Resources are not used productively or efficiently
    • C. Investment is often unbalanced so much is ineffected

For a contrast, see the theory of the decentralized market economy as described by Friedrich von Hayek .

Post World War II Collapse and Recovery

The Occupation

The Occupation Authorities in the American, British and French Zones kept the economic policies of the Nazis in place. There were price controls, rent controls, wage controls and extensive general regulation of the economy. The net result was an economic disaster and the creation of near-famine conditions. But the loosening up of controls brought up the problem of the past excessive expansion of the money supply. Inflation had been suppressed during the Nazi years by price controls. With the removal of price controls came inflation.

The Currency Reform of June 1948

The long anticipated currency reform came in June of 1948. The old Reichsmark was replaced with the new Deutschemark. The conversion was as follows:

Individuals600 Reichsmarks 1 Reichsmark: 1 Deutsche Mark
exceeding 600 Reichsmark
  10 Reichsmark: 1 Deutsche Mark
Companies60 Reichsmarks
per employee
1 Reichsmark: 1 Deutsche Mark
Public AuthoritiesOne month's revenue 1 Reichsmark: 1 Deutsche Mark
All others  10 Reichsmark: 1 Deutsche Mark


  • Balances exceeding 600 Reichsmarks:

    Supposedly converted at 10 Reichsmarks: 1 Deutsche Mark but the method of payment resulted in the conversion being actually 10 Reichsmarks: 0.65 Deutsche Mark or 15.4 Reichsmarks: 1 Deutsche Mark.

  • Debts were converted at the 10:1 ratio.
  • Official prices and pension payments were converted at a 1:1 ratio.
  • The Reichsmark balances and Reichsmark bond holdings of commercial banks were wiped out but these banks recieved "equalization claims" equal to 4% of debt (25:1 conversion ratio) and deposits with the central bank of West Germany equal to 15% of demand deposits and 7.5% of time and savings deposits. The required reseverve ratios were 7.5% for demand deposits and 3.75% for time and savings deposits so the banks had excess reserves to support lending.

The central bank of West Germany was called the Bank Deutscher Lander until 1957 when its name was changed to Bundesbank (Buba).

1948-1960 Spontaneous Growth: The Miracle Economy

The monetary, economic and institutional reforms of June 1948 were followed by about 18 months of consolidation with stable to slightly falling prices.

Industrial production increased by 24% in 1949 and 12% in the first half of 1950. Over the period the average annual growth rate was 15% per year.

The employment growth picture was mixed. Labor requirements reflect not only the level of production but also the level of labor productivity. Labor productivity was increasing dramatically in the recovery period. In 1948 there were 600,000 new jobs but a loss of 370,000 old jobs for a new gain of 230,000. But in 1949 the were only 260,000 new jobs and a loss of 410,00 old jobs for a net loss of 150,000 jobs.

On top of this mixed picture on job creation there was an influx of 9 million refugees (expellees and immigrants).

The major problem was the capital shortage. Not only was there the problem of the war destruction of capital but the reparation confiscations of capital equipment depleted the capital stock and made entrepreneurs afraid to invest because of the possibility that their investments might be confiscated in the future.

Profitability was increasing because wage rates were not increasing as fast as prices and productivity. In other words, unit labor costs were declining.

The prescription for dealing with the capital shortage problem by the Keynesian economic advisers to the government was three-fold:

  • 1. expansionary monetary policy
  • 2. tax incentives for saving
  • 3. investment planning by the government

William Ropke, an economist whom Americans would call conservative but in European terminology is called liberal, recommended increasing the interest rate to encourage savings.

The Tax Law Adjustment Acts of June 1948 and April 1949 created tax breaks for capital creation. West Germany had a high, graduated income tax imposed by the Allied Occupation Force after World War II modeled upon the New Deal income tax of the U.S.

There were income tax reforms over the period 1948 to 1955 to reduce the severity of the income tax program.

The West German government was directed involved in investment planning in the "bottleneck sectors" of mining, steel and energy.

West Germany retained the rent control program created during the days of the Weimar Republic, continued by the Nazis and later by the Occupation. There was thus a chronic shortage of housing which the government tried to alleviate with construction subsidies and public housing.

German foreign trade recovered dramatically despite the loss of Eastern European markets. Foreign trade increased 84.4% per year over the two year period 1948-1950. Throughout the 1950s it increased 16% per year in real terms. Thus West Germany very quickly wiped out its trade deficit and commenced running a trade surplus. Initial exports were raw materials such as coke from coal and scrap metal but by the end of the 1950s exports were mainly manufactured goods. Also by the end of the 1950s Western Europe had become the major customer and major supplier for West Germany.

Towards Managed Growth

The 1960s and 1970s:

  • Full or overutilization of capital
  • Labor Force fully utilized. Unemployment rate approximately 1 percent.
  • Undervalued currency.
  • Influx of Gastarbeiter.

The Role of the Gastarbeiter (Guest worker). (To be continued.)

Demand Management to Control Inflation and Establish External Balance

In the mid-1960's the German parliament created an independent five-person panel called The Council of Economic Experts. Karl Schiller, who was Minister of Economics from 1966 to 1972, carried on an extensive debate with the Council.

The Recession 1967. (To be continued.)

Growth rates declined from miracle economy levels to normal levels for modern industrial economy. The Harrod-Domar growth model gives some insights into the dynamics of growth. See

The Harrod-Domar Growth Model.

Let Y be GDP and S be savings. The level of savings is a function of the level of GDP, say S = sY. The level of capital K needed to produce an output Y is given by the equation K = pY where p is called the capital-output ratio. Investment I represents an important component of the demand for the output of an economy as well as the increase in capital stock. Thus ΔK = pΔY. For equilibrium there must be a balance between supply and demand for a nation's output. In simple case this equilibrium condition reduces to I = S. Thus,

I = ΔK = pΔY
and I = S = sY
Therefore ΔY/Y = s/p

The equilibrium growth rate of output is equal to the marginal propensity to save to the ratio of the capital-output ratio.

1973-1989 Facing the Slowdown

  • A. Persistent unemployment (nature of unemployment, slack growth)
  • B. Adjustment to external challenges (Protectionist temptations, current account debate, international monetary coordination)


  • For material on German reunification go to this site.

(To be continued.)


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