“Querying economic orthodoxy”

No. 32 - July 2008

Refreshment from Germany


            The selfish instinct of individual acquisitiveness finds its necessary corrective in the lively feeling of neighbourliness, in the clear understanding that that the prosperity of each member of the community depends closely on the prosperity of all, and that all depend together on how well or badly the local administration works.

            Gustav von Schmoller, Grundriss der allgemeinen Volkswirtschaftslehre [Principles of General Economics] (Duncker & Humblot, Munich/Leipzig, 1900), book II, sect. 112

            Those now living in the extended order gain from not treating one another as neighbours, and by applying, in their interactions, rules of the extended order - such as those of several property and contract - instead of the rules of solidarity and altruism.

            Friedrich von Hayek, The Fatal Conceit (Routledge, London, 1988, reprint 1992), page 13

            In democracies of the purest form they pursue a method which is contrary to their welfare; the reason of which is, that they define liberty wrong....in such a democracy everyone may live as he likes, "as his inclination guides" in the words of Euripedes: but this is all wrong, for no-one ought to think it slavery to live in subjection to government, but rather protection.

            Aristotle, Politics, trans. William Ellis, book V, chap. ix (1310a)

            The only acceptable alternative to bad government is good government. It is vain to think that we can solve the problems of misrule by minimising the state. We have no realistic choice but to keep up the continuing struggle to establish and maintain the virtuous state.

            An antidote to mainstream economics

            Orthodox economics today is an arid and rebarbative subject. See, for example, the quotation above from one of its most revered gurus, Friedrich von Hayek. He, like his teacher, Ludwig von Mises, objected vehemently to any attempt by the state to mitigate glaring inequalities. Milton Friedman, another idol of the cult, held (1) that the more unfair competition the better; however, as the British economist Richard Layard has observed (2), we've made a virtue of competition, which means other people are a threat, not a support. Ayn Rand, the Russian-American eulogist of unbridled capitalism, kindly informed us (3) that there are no "rights" to a 'fair' wage or a 'fair' price if no-one chooses to pay it. Though she died in 1982, her books are still best-sellers in America.

            O dear! Try, for a change, the philosophy of the 'Historical School' of economists in 19th-century Germany. Never heard of them? I'm not surprised. They have long been as unfashionable as Marx has recently become; and they are much less accessible than Marx; for most of their work is out of print, has never been translated into English, and can be found only in scholarly research libraries. The British and the Americans have generally been too deeply obsessed with the economics of Adam Smith and his (generally less enlightened) followers to take much notice of anything else. But it was German economics that built the robust industrial economy which had overtaken British industry by the end of the nineteenth century and survived it by the end of the twentieth.

            To dip into those forgotten Prussians after an overdose of Hayek or Mises (these two were Austrians) is as refreshing as a Stein of Dortmunder or Löwenbräu on a hot, sticky afternoon. Those German economists were practical and humane. They were not much interested in theories; they did not see economics as a science like astronomy, in which the behaviour of stars and planets can be predicted with the help of complex mathematics. They thought it more akin to psychology; economics, after all, is about human behaviour. In fact, they deliberately reacted against the mechanistic economics of the 'classical' (Adam Smith) school, the basis of modern orthodoxy.

            An arrogant ideology

            Western economists have for many years had the bad habit of setting up mathematical theories describing how economies work, then arrogantly asserting that these theories are valid universally, at all times and in all places. Thus they feel justified in going out into the wide world and telling everyone from Russians to Africans or Latin Americans how to run their economies. The Germans took a different approach. They studied history to see what actually happened in the economies of various countries and cultures. That is why they are known as the Historical School; they preferred historical fact to pseudo-scientific theory.

            Mainstream economics does not encourage us to behave like good neighbours; indeed, as you will have noticed from Hayek's comment above, it even does the exact opposite. It exhorts us to spend our lives trying to get the better of each other. It is obsessively individualistic; it asserts that we cannot have a successful economy unless everyone struggles, independently and single-mindedly and without regard for the public good, for his own greatest advantage; unless no-one admits that he depends upon the goodwill of others and has a corresponding obligation to show goodwill towards other people. Self-reliance is the watchword; as if any human being could ever be entirely self-reliant; or would, as a normal and reasonable person, wish to be so.

            The German alternative

            The German economists were in sympathy with working people, unlike the classical eonomists who regarded labour simply as a cost of production, to be paid as little as was necessary to keep it alive. Gustav von Schmoller (1838 - 1917) was the dominant member of the Historical School. In 1872, he and his colleague Adolph Wagner (4) founded an association of economists, the Verein für Sozialpolitik, which advised Bismarck's government. Hear the Spanish economist José Tomás Raga Gil, of San Pablo University in Madrid (5): from the outset, the Verein gave particular attention to work in its social context. Wage levels and wage improvements, the training of employees (the improvement of human capital), working time, social security and social services etc. were the areas where the Verein promoted by these two economists was most active.

            They were concerned with the welfare of the people; and, as practical men who had no more time for Marx's theories than for Ricardo's, they were anxious to ward off the threat of communism, which was very real in late nineteenth-century Europe. They saw the pressing need to run their economy in such a way that ordinary people were reasonably contented and hence unlikely to be seduced by revolutionaries. So they favoured a strong public sector providing good services, yet kept in balance with the private sector.

            The views of Gustav von Schmoller

            Since Professor Schmoller, in charge of economics teaching and appointments in Berlin between 1882 and 1913, was the dominant figure in the Historical movement, and since his Verein was an influential advisor to the government, his views helped to set the tone of German economic doctrine and policy for many years. Let us see, therefore, what he had to say on some major issues.

            For him, classical theory was far too simplistic (6): it is childish to believe that we can find in the theories of Quesnay (7), Smith, Ricardo, and John Stuart Mill anything more than a first provisional attempt at a systematic science.

            He rejected (8) the very idea of fixed and unchanging economic principles of universal application. There are not, and never can be, supreme laws governing the action of economic forces. And he accused (9) the classical economists in biting terms of a fault that is easily recognisable in our own times: the more their hollow theories became removed from observation and from the practical needs of life...the less valuable were the productions of the classical school. It finished, like a weapon of the class war, by being handed over by Mammon itself to the capitalists, a scientific toy devised by cloistered scientists, out of touch with the world.

            He recognised (as did Marx, whose doctrines in general, however, he detested) the value of work not only as a factor of production, but also as necessary for human well-being (10): all moral strength has its roots in work.

            He had no time for the 'iron law of wages', stated by Turgot (11) in the following terms and later taken up by Ricardo: in every kind of work it must happen, and does in fact happen, that the worker's wages are limited to what is necessary for his subsistance. On the contrary, for Schmoller (12) it is a sign of progress when the lower classes themselves demand meat, good clothes, agreeable lodgings, their share in intellectual culture; it is progress when all classes of society wish at all costs not to reduce their standard of living, but rather to improve it.

            He scorned (13) the general doctrine that egoism and the desire for personal acquisition...are, by themselves, the foundation of political economy. On the contrary, he held (14) that the acquisitive instinct, in itself, is bad, even deranging, from the economic point of view.

            He favoured a strong and extensive public sector, run largely by municipal authorities rather than by the central government. He admitted (15) that services such as water, gas, electricity...can without too many problems be left in the hands of private industry on condition that they be tightly controlled by the local government; otherwise there could too easily be excessive gains for the monopolists and very bad services for the public. The municipality should also be responsible for the education and training of children and adults. Among other functions that could well be handled by the municipality or the state, he mentioned assistance for the poor, the construction of hospitals...obligatory health insurance...savings banks, pawnbrokers, even in some cases banks and mortgage lenders.

            He saw good reasons for nationalising the railways, perhaps also coalmines, steelworks, power stations...Competition between the railways represents a waste of national resources.

            However, Schmoller was no outright socialist. he abhorred communism, which he considered (16) a centralised despotism. In fact, he called for a balance between public and private sectors (15): the public economy should not absorb the private, or vice versa. He favoured a decentralised system with many powers exercised by local rather than central government.

            Reactions to to Communism: Berlin v. Vienna

            In the latter part of the nineteenth century, a spectre was haunting Europe - the spectre of Communism, as Marx and Engels had stated (17) in their 1848 Manifesto. The Austrian and German economists reacted in diametrically opposite ways to this challenge. German economists, as we have seen, proposed a mixed economy, with extensive social services and considerable state intervention, to mitigate the asperities of capitalism and encourage better education and living standards for the working classes. Their doctrines formed the basis for modern German 'social market' (die soziale Marktwirtschaft) policies, which have been widely imitated in Europe, especially in the northern countries. They argued that by helping the working classes towards a better life they would break the vicious circle described by Marx, in which an increasingly deprived and demoralised proletariat would explode in revolution. History shows that their strategy, whatever its difficulties, has by and large worked.

            The Austrians, by contrast, insisted (and their modern successors still insist) that any form of state intervention, however moderate, is a step on to the slippery slope that leads to totalitarianism. The only way to avoid this slope, they say, is to eliminate the economic and regulatory activities of the state and have a totally free-market economy. But their argument is logically twisted. It was, in fact, the horrid consequences of free-market dogma, especially prevalent in the first half of the nineteenth century, that spawned the development of totalitarian Marxism. Neo-Austrians would like to persuade us that Bismarck's benevolent social policies led to Nazism, but that is not convincing. Similar policies have been followed in Scandinavia, in France, even in Britain in those far-off pre-Thatcher days. Do you seriously want to blame (18) William Beveridge for the British National Party?

            Neo-Austrians and other libertarians insist that the only alternative to the oppressive totalitarian state is the minimum state; that the only alternative to bad government is as little government as possible, or even (for anarchists) none at all. But, whatever they may argue in theory, practical experience shows that weak government leads to strife and injustice; as, in the same year as the Communist Manifesto, the French Dominican priest Père Lacordaire eloquently observed (19): between the strong and the weak, between the rich and the poor, between master and servant, it is liberty that is oppressive and the law that sets free.

            The only acceptable alternative to bad government is good government. It is vain to think that we can solve the problems of misrule by minimising the state. We have no realistic choice but to keep up the continuing struggle to establish and maintain the virtuous state.

            * * * * *


            1 Milton Friedman, quoted by Michael Ignatieff in 20/20, BBC Radio 4, 5 February 1997

            2 Sir Richard Layard, professor at the London School of Economics, quoted by Catherine Mayer in Time, 7 April 2008, page 40

            3 Ayn Rand (1905 - 1982), Man's Rights in The Virtue of Selfishness (1963)

            4 Adolph Wagner (1835 - 1917), professor of political economy in Berlin from 1870, was a notable economist of the Historical School. He is remembered for Wagner's Law, which states that as a society becomes more developed, the proportion of public spending to total output tends to rise. This appears to conflict with Schmoller's principle that the public and private sectors should be kept in balance.

            5 J T Raga Gil, A New Shape for the Welfare State, Pontifical Academy of Social Sciences, 8th plenary session (April 2002) (see link)

            6 Gustav von Schmoller, Grundriss der allgemeinen Volkswirtschaftslehre [Principles of General Economics] (Duncker & Humblot, Munich/Leipzig, 1900), introduction, #41

            7 François Quesnay (1694 - 1774), an economist of the group known as the Physiocrats, was an early advocate of free trade and minimal state intervention. He regarded agriculture as the source of all national wealth.

            8 Schmoller, op. cit., #46

            9 Schmoller, op. cit., #40

            10 Schmoller, op. cit. #20

            11 Anne-Robert-JacquesTurgot, Réflexions sur la Formation et la Distribution des Richesses (1769) para. 6

            12 Schmoller, op. cit. #12

            13 Schmoller, op. cit., #17

            14 Schmoller, op. cit., #19

            15 Schmoller, Grundriss, book II, #112

            16 Schmoller, op. cit., #

            17 Karl Marx and Friedrich Engels, Manifesto of the Communist Party (1848), foreword

            18 William Beveridge (1879 - 1963), economist and advisor to the British government, was the prime mover behind the early development of the welfare state in Britain. The British National Party is a small extreme right-wing (neo-fascist) group; for more details see my essay Luttwak's Wave of Fascism, in this series, November 2006

            19 Henri-Dominique Lacordaire OP (1802 - 1861), speech given at the 52nd Conférence de Notre-Dame, Paris, 1848