Nov 11, 2020

German Economic Miracle

World War II ended with the defeat of the Axis Powers – Imperial Japan, Nazi Germany, and Fascist Italy. The war caused tremendous economic damage to the whole of Europe through the most adverse impact of the war was on Nazi Germany.

Adolf Hitler's Nero decree detailing a scorched earth policy ordered massive destruction of German infrastructure to prevent its use by the approaching Allies. It is believed this order destroyed 20% of all remaining infrastructure.

The German economy further lay in shambles with the division of the country into four zones by the Allied Powers. The United States of America, Great Britain, France, and the Soviet Union were each given a zone to govern. The Western allies carved out the nation of West Germany by agreeing to conduct joint administration of their three zones.

Meanwhile, the remaining territory renamed East Germany was under the firm control of the Soviet Union. In the late half of the 1940s, these zones took the form of independent nations - West Germany becoming the Federal Republic of Germany and East Germany became the German Democratic Republic.

Many thought that Germany would subsequently become an underdeveloped nation. However, in the coming years, people watched in bewilderment as it rose to be one of the most developed countries with a robust economy envied by the world. In this article, we shall take a look into the German Economic Miracle or Wirtschaftswunder.

The Pre-War Economy

Most of the German cities had faced terrible bombing and disintegration of industries by Allies. Consequently, industrial production was one-third, and food production at 51% of the 1938 level. A crippled agricultural sector resulted in terrible food shortages and even starvation. Most of the men, between 18 and 35 that comprised the majority of the labor force, had died, or were disabled.

The Nazi government had imposed price ceilings on most goods and commodities back in 1936 to allow the purchase of raw materials required for war at artificially low prices.

Between 1936 and 1944, the government increased price controls by 14% while the money supply had risen more than six times. The imposition of price controls disrupted the natural equilibrium between supply and demand forces. The artificially depressed prices of goods and commodities in the open market prevented suppliers from selling a good at its real value. This led to the formation of a massive black market and bartering system. More than 50% of the economic transactions happened in the black market. By the time, the nation separated, the price controls remained in place along with a thriving black market.

While the economic turmoil was going on, there were millions of ethnic German refugees entering West Germany. Most were fleeing the spreading communist regime from the East. With most of the infrastructure already destroyed due to war and capital shortages, facilities like housing, electricity, and water, etc. were difficult to provide to these refugees.

Despite this, West Germany grew impressively from 1948 to 1960. Throughout the early 1950s, West Germany registered an impressive GDP growth rate of 15 percent annually. This period of economic recovery was possible through structural and institutional reforms, foreign aid, and improved industrial production.

The Minister for Economic Affairs, Ludwig Erhard is credited for this success and referred to as the Father of the German Economic Miracle for introducing currency reforms and abolishing rationing and price controls.

Social Market economy

The Nazi policymakers followed protectionist policies and aimed towards self-sufficiency. The economy was heavily focused on military spending and rearmament to conquer other nations and fulfill their domestic needs.

This approach changed entirely when the Allies occupied Germany. They stopped the production of arms and ammunition and deindustrialized the industries relating to them. Instead, they followed the policy of a social market economy.

The social market economy is an economic model in which the concept of a market economy combines with the principle of government intervention to ensure social justice and economic equality. The State interferes to prevent exploitation of the poor and the formation of cartels and monopolies.

Along with the social market economy, the administrators pursued flexibility to adapt to changing events, rather than being guided by a definite ideology that would become antiquated with time.

Currency Reforms

From 1945 to 1948, the situation did not improve much. Shortages and the black market were still prevalent with low industrial production unable to meet consumer demands. There was a need for revolutionary change to eliminate the problem.

Economics Professor Wilhelm Röpke exclaimed that the German economy was in a state of repressed inflation. According to Ropke, currency reforms and the abolition of price controls were necessary for fuelling economic growth.

On 21 June 1948, Ludwig Erhard introduced currency reforms wherein the new currency - Deutsche Mark would replace the erstwhile Reichsmark. The money supply was reduced by 93 percent, eliminating the problem of excess money in the market. Later on that very day, Ludwig in a radio address to the nation announced the abolition of price controls. The move prompted sellers to revert to the open market as they could now sell the goods at fair market prices. The otherwise stagnant economic activities sprung to life.

Government revenue from taxes on commercial activities skyrocketed, creating funds for public investment in infrastructure and services. The previously underestimated Gross Domestic Product (GDP) rose dramatically as the earlier black market did not come under regulation and government statistics.

Agriculture and Industry

The currency reforms also improved the situation in the two most important sectors of the economy - Agriculture and Manufacturing.

The sudden demand for consumer goods and independence to decide product prices stimulated industrial growth. The refugees coming from East Germany were technically skilled workers who fulfilled the labor requirement. Factories again began to operate while absenteeism among labor plummeted.

The West German government had low defense expenditure because of demilitarization by the Allies.

As a result, the government had a budget surplus despite colossal social spending leading to investments in the bottleneck iron and steel, coal mining, and energy sectors. Just like the bottleneck is the narrowest part of the bottle and water moves through it at the slowest speed. These sectors endangered the effectiveness and further expansion of industries. To eliminate this problem, the government channeled its extra funds into these sectors.

In 1952, the government passed The Investment Aid Law. Under this law, businesses had to buy securities worth 1 billion DM from bottleneck sectors. Humongous capital infusion enabled the transformation of these sectors. This decision turned out to be highly effective but also unpopular because it was a direct arbitration by the government. Government funds further increased substantially from foreign aid.

From April 1948 to June 1950, the Federal Republic of Germany received a total of $ 2.031 billion in foreign aid. Of all aid programs, the European Recovery Program, popularly known as Marshall Plan, was the largest contributor.

In the Marshall Plan, Western Europe secured nearly 15 billion dollars provided. Germany was one of the largest recipients at 11 % of the total amount. It provided the necessary funds and means to change West Germany from autarky to an export-driven economy. Thus it proved to be helpful in the economic recovery of not only West Germany but also of other European countries.

To raise capital from the market and individuals, the government introduced fiscal measures and gave tax incentives. The government gave priority to increase the volume of savings, which the banks would then use to extend loans to industries. The major capital contributors were businesses. The profit-making merchandises were encouraged to invest their earnings rather than giving it out to shareholders.

The income produced from this investment was non-taxable. This increased capital accumulation, by both government and market, resulted in better industrial production. As volume and quality of production increased, so did exports. Even today, Germany is the leading exporter of high quality manufactured goods in the world.

Institutional and Policy Reforms

The economic miracle of Germany was through the combined effort of market mechanisms and government policies. The currency reforms and abolition of price controls ensured monetary stability, increased industrial production and capital formation contributed to increased employment and per capita income. These measures and policies set West Germany on a path of economic prosperity that made it the third-largest economy in the world in 1989.

Since its formation in 1948, Germany followed a unique approach to the national economy. They clubbed the two major economic ideologies- capitalism and socialism - such that they would mitigate the defects of each other. It allowed them to promote economic growth as well as social goals such as full employment, access to healthcare, and education.

It should serve as an example for developing nations on how they can shape their economic policy to fulfill their dual objectives - economic growth and social equality.



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