A German lesson

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The great German experiment teaches us a great deal. One of the lessons is that microeconomic policy is of critical important.

One of the weaknesses in the claim that social sciences are sciences at all is their inability to conduct controlled experiments. Physicists can create vacuums, chemists can establish sterile environments, even doctors can conduct blind trials. But economists, sociologists, political scientists and those who study management find their subject matter will never stand still.

But there has been one great controlled experiment in economics. It began fifty years ago, when one of the world’s most successful economies was divided into two zones. In one, there was a powerful central planning agency, able to assess needs and co-ordinate production plans. In the other, people were left to do pretty much what they liked.

The country in which the experiment was conducted was Germany, and a few years ago the results came in. One third of the way through, it was necessary to build a wall to keep the experiment going, otherwise the inhabitants of one zone would mostly have fled to the other. The end came when they tore down the wall and fled anyway. It is difficult to be exact, but most observers agree that living standards in the West were at least twice those of the East by that time.

Since it is the only controlled experiment on that scale we have, we ought to analyse the results rather carefully. One lesson is that the macroeconomic issues which typically preoccupy politicians and the press – what will happen to interest rates, how large is the budget deficit – are not really of much importance. West Germany had an exemplary record in the management of monetary and fiscal policy, but almost no one believes that this was why West Germany ended up rich and East Germany poor. The reasons were entirely microeconomic – to do with the different ways markets and industries were organised in the two zones.

If you doubt that, remember that the reason German macroeconomic management was so disciplined in the post war period was a reaction to experience when German macroeconomic management was so undisciplined in the 1920s. For a time, there was no control at all over the currency or the level of public expenditure. The political consequences for Germany proved to be substantial, but the impact on German productive capacity was slight and temporary. No inflationists have ever done the amount of damage to overall living standards achieved by the East German planners.

So is the real lesson that politics should not be allowed to interfere with the process of production and exchange? There is something in that, but this too requires thoughtful interpretation. There were many things the East German regime had to worry about, but winning elections was not one of them. East Germany was quite unusually free from the clamour of tabloid headlines, the exigencies of parliamentary debate, and the electoral pressures which make the economic policies of western governments irresponsible and short term in orientation.

In reality, East German production was controlled by a self-perpetuating bureaucracy. Neither in structure, nor in the background ability and training of those involved, was it very different from the self-perpetuating bureaucracies that control large corporations in the West. Nor should we think that devotion to the cause of shareholder value was a more powerful spur to efficiency than the advancement of the dictatorship of the proletariat. Fortunately, neither rhetoric has much effect on what anyone actually does. It was true that advancement in East German bureaucracy depended as much on ones obedience to the prevailing orthodoxy as on evidence of performance on the job, but then isn’t there something of that also in Siemens, Shell and General Electric?

The essential difference between East and West was the difference between centralisation and decentralisation of economic power. Much of the West German economy was also run by hierarchical political organisations, but there were many of them. Ideas neglected in one would be tried in another, and the easier comparison of performance made failures more obvious. The East, deprived of this, made few drugs and lousy televisions. What went on a restaurant menu could be decided locally by people who knew their customers, not by a planning agency; the same reason why French hotels are better than Little Chefs. Fragmented structures facilitated innovation, processed more effectively the masses of information needed to run a modern economy, and gave individuals a sense of responsibility for the consequences of their own actions.

But if that is what the experiment was about then the result is not what most people would have predicted. It is and remains counter-intuitive that decentralised economic systems out-perform planned and co-ordinated ones.

But that result – that decentralised economic systems out perform planned and co-ordinated ones – is and remains counter intuitive. And it is only since the results of experiments like the German one have been understood that the efficiency of decentralisation has been recognised as an empirical as well as a theoretical truth. It is not so long since we saw sputniks in the sky, and people on the right as well as the left feared that, repellent through the totalitarian regimes of Eastern Europe might be from the perspective of civil liberties, they might be more successful economically.

We now know that view is ludicrous, but have not fully taken the implications on board. We are still inclined to think that large firms, with co-ordinated massed resources, are bound to win out against diffuse and decentralised forms of organisation; that our companies will benefit from a strong central authority with a well-defined common purpose. There is a striking resemblance between the cults of powerful chief executives, with the propagation of corporate visions, between the endless restructuring and change management programmes of modern corporations, and the political posturing of dotty dictators. No one should think that the superior performance of free enterprise economies over socialist ones came about because business people were wiser than politicians, or of superior moral stature. Its the economic system, stupid.

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