Economics of the Third Reich and Western Economic Thought

Author: Tomasz Blusiewicz

Economics of the Third Reich and Western Economic Thought

Draft: do not cite

1. Introduction

The swift and successful economic recovery in Germany after the Great Depression was a phenomenon that was noticed and frequently referred to by observers in Germany and abroad. Among economists and scholars who were experts in this field, roughly two groups can be distinguished. The first group argued that the quasi-totalitarian character of the Nazi state rendered any purely economic analysis inapplicable[1]. They believedthat the strict state controls imposed on the operation of market mechanisms made the economy virtually invulnerable to the classic problems associated with deficit finance and rearmament-driven output boom such as inflation, upward wage pressures, consumer goods shortages or inflexible production structure. This group was generally in majority and especially so throughout the duration of the Second World War. The second group, which began to question that position after the war, subscribed to a different view[2]. Those scholars argued that the means of recovery applied after 1933 had reached their limits by 1938 and that there were serious challenges ahead of the German economy such as massive inflationary overhang, capital-deprived private markets or labor and resources shortages, to mention just a few. The price, wage or mobility controls introduced by the Nazis were perceived by them as inefficient and unable to prevent the basic macroeconomic mechanisms from kicking in at some point in the near future. They also considered the pre-1939 economy of the Third Reich as similar enough to Western economies to enable the application of standard economic tools of analysis of the time.

The binary division presented above is a gross, but useful simplification. I would like to use it as a preliminary scheme to begin the examination of how Western economists evaluated the performance of the German economy between 1933 and 1939, how they reacted to numerous economic innovations introduced by the Nazis and whether these innovations were considered to pose a challenge for the macroeconomic theory of the time. I argue that both the experimental nature of economic policies in Germany between 1933 and 1939 and the way it penetrated and influenced Western economic thought were important moments in its history. I also suggest that the revisionist group of economists developed a more nuanced and accurate picture and that it facilitated a debate about possible theoretical implications of the case in question.

There were several features of the Nazi economy that posed theoretical problems for Western economists which then gave birth to a series of controversies. On the most fundamental level, the question was whether the Nazi economy could be treated as a market economy at all and whether the post-1933 means of recovery were Keynesian and if yes - to what extent[3]. Depending on the answers, issues such as, for example, the extent to which deficit finance was a feasible long-term policy or the effectiveness of anti-inflationary control tended to be among the most frequently debated topics. I attempt to show that both the unprecedented nature of the Nazi economic policy and its (at least initially) surprising outcomes, served as a platform to question some of the tenets of neoclassical economics[4], even if they were not sufficient on their own to decisively undermine them.

1. Historical Background

The period between the Sudetenland Crisis and the Anschluss of Austria was a period of international tensions unseen in Europe since The Great War. Some scholars also identified this moment as a key turning point in the economic history of the Third Reich. They argued that it was the last moment when macroeconomic stability could have been reestablished in Germany[5]. Because it did not happen, the only way for the Nazi leadership to avoid either inflation or radical financial austerity was to push for a full scale war economy and eventually for war itself. Leaving political considerations aside, this period also saw an escalation of the conflict between the Reichsbank and Adolf Hitler. The officials of the Reichsbank claimed that an additional volume of deficit funding and monetary expansion would certainly result in offsetting an uncontrollable inflationary spiral which would in turn ruin all the progress won until then[6]. The Reichsbank lost this struggle, its president Hjalmar Schacht was dismissedand the Nazi leadership continued the expansionary financial policies on an even greater scale in 1939[7].

As a matter of fact, the official price index in Germany grew only by 1 percent in 1939 and the developments predicted by the Reichsbank did not take place[8]. This situation sparked a debate among economists: how does one explain the fact that a 22 percent expansion in monetary base in 1938[9], to a large extent sponsored by the Nazi printing presses coupled with a failure to float bonds on the open market, did not give birth to any loss in the purchasing power of the Reichsmark? Foreign observers wrote about a financial miracle “accomplished by means of mysterious conjuring tricks”[10]performed by Schacht and called him a magician[11]. Some were overawed with Nazi market control measures and spoke of subjugation of economic laws to the machinery of modern state[12]. Others interpreted this policy as a mere delay tactics while the most perceptive ones saw a military conflict looming on the horizon[13]. All of them were right to some extent. However, producing a ‘correct’ explanation of the developments in question is a secondary aim of this essay. The primary goal is to look how thedebate as a whole was both a reflection of contemporaneous trends in economic thought and what role it played in preparing the ground for the Keynesian ascendency after the war.

It most general terms, the debate about the sustainability of the post-1933 German recovery was coterminous with the gradual decline of the gold standard system, both as a theory and a practice, up until its eventual collapse[14]. Parallel to it was the increasingly more determined attack on the tenets of traditional financial and monetary practices, which the German case was perceived by some to prove mistaken. Publication of The General Theory by John Maynard Keynes in 1936[15] was an important moment in this context, after which many economists began to ask whether its principles had been applied in Germany and to what extent. The Great Depression’s impact on economic thought was revolutionary and the German recovery contributed to this paradigm shift in at least two ways. Within the Keynesian strand of the debate, it was sometimes seen as a more radical yet commensurate method of ‘priming-the-pump’ and state-activated stimulus that helped to combat the slump. Secondly, it also played a role in reshaping the way that economists thought about state planning and market control, which then moved to the center of public discourse in Europe after the war.In both ways, the Nazi experiment was another element that in its own convoluted way contributed to the then seemingly ultimate eclipse of classical liberalism and laissez-faireism, both in its liberal-democratic political branch and the original, free-market oriented economic core.

1. The initial reactions

The conditions of both access to reliable information and expression of ideas in Germany were gradually worsening in the 1930s.However, they had never reached anything similar to the information blockade practiced in the Soviet Union at the time. In fact, it was still possible for both domestic and foreign scholars to get a sense of the direction in which the economy was heading and to publish their findings either at home (if they were not explicitly anti-state) or abroad. There were regular statistical publications issued by the Reich’s Statistical Office or by the Institut fur Konjunkturforschung as well as the Reports of the Reichskreditgessellschaft. The academic environment and various professional periodicals were functioning alongside state propaganda efforts. Doubts about the credibility of official statistics and about the independence of respective institutions began to proliferate especially after the introduction of the Four Year Plan in 1936, but in general the deformative impact of the Nazi state on information quality and accessibility should not be exaggerated, nor should it be completely neglected.

Writing in December 1938, the University of Cambridge economist C.W. Guillebaud went further. He claimed that “the deliberate manipulation of official statistics would be an administrative impossibility in Germany, where the whole economic system is based on the existence of accurate quantitative data.”[16]With the advantage of hindsight, such a view might seem an exaggeration. Maxine Sweezy, an American economist writing in Cambridge for the Harvard Studies in Monopoly and Competition, was more careful and spoke about “fairly reliable [statistics] if used carefully and critically.”[17] Nonetheless, the mere fact that a British economist was inclined to think in such terms in 1938is indicative that the problem of sources and information in general was not a significant one for contemporary authors, not mentioning those who wrote after the war.

Guillebaud’s study The Economic Recovery of Germany: From 1933 to the Incorporation of Austria in March 1938 was actually the first in-depth analysis that appeared in Western literature. The author was under a strong impression of the post-1933 progress and underscored“the contrast […] between the economic stability and comparative well-being of Germany, and the poverty of Russia, or the fluctuation and unemployment of Britain, France and the United States.”[18] Guillebaud was also optimistic about the prospect of the German economy in 1938: “… the hope of still better times to come can be held up before the eyes of the German worker with a considerable measure of probability that it will be realized.”[19] On a theoretical level, he pointed to an article by Richard F. Kahn in the Economic Journal in 1931[20] as an anticipation of the deficit financing mechanism subsequently applied by the Nazis:

“…the creation of money cannot produce an inflationary rise in the general level of prices, with all its attendant evils, so long as there is an abundant amount of idle resources and unused productive capacity available. […] It is true that there are two conditions which must be fulfilled in order that this general proposition may be valid: there must be substantial stability of the level of efficiency wages, and the process of money creation must not be accompanied by the export of capital on a large scale, i.e. by a flight from currency. But in Germany both these conditions have in fact been satisfied as a result of direct state intervention.”[21]

At the same time, Guillebaud dismissed the importance of German economic thought behind the birth of the new system. In fact, he doubted any purposeful reliance of National Socialism on economic theory in general[22]. “Since the appearance of Keynes’ General Theory, many Germans have tried to rationalize their official policy by reference to his theories. Independently (in whole or part) of Mr. Keynes, German economic writers, such as Richter Althschaffer, Nahmer, Gruning, Fohl and others, have developed theories on somewhat similar lines.”[23] However, “there is no evidence to show that the original policy was influenced at all by abstract theories.”[24] Guillebaud pointed to Gottfried Feder as the only “theoretician” who might have in some way influenced Nazi policies, but his leftist agenda was sidetracked and remained largely irrelevant after the Machtergreifung of 1933.

Guillebaud was aware of the opinion shared by many observers that “the pace [of recovery] is too hot to last, and Germany is on the verge of a catastrophic collapse.”[25] He refrained from a clear verdict and admitted that “many […] problems are new in the sense that there is no precedent or historical analogy in the past which can serve as a guide to current policy.”[26] Nonetheless, he believed that certain macroeconomic laws could not be held in abeyance indefinitely. There were two inevitable outcomes of excessive deficit financing and which one of them would follow was a matter of policy. “If the volume of investment outruns the amount of saving which the public as a whole can be induced […] then either an income and price inflation must result, or, if prices and wages are kept down by state intervention, scarcities must ensue leading to the formation of queues and eventual rationing of consumption.”[27] Therefore, if inflation is avoided and the system of price and wage control works as efficiently as before, shortages must follow due to full employment, high aggregate purchasing power and the shift to war economy at the expense of consumer economy. In the final analysis however, the Cambridge economist remained optimistic: “So far as the reasonably near future is concerned, and assuming the absence of war, it would seem more probable that the German economy will grow stronger than that it will collapse or decline.”[28]

Several months later, Harvard University Press published another in-depth study entitled German Financial Policies 1932-1939 by Kenyon E. Poole, Professor of Economics at Brown University. Poole focused explicitly on investigating the “mechanisms involved in achieving full employment through state spending” and their implications to throw light on the hitherto general debate about “the relative virtues of inflationary and deflationary measures as a means of attacking the unemployment problem.”[29] However, accurate knowledge about the financial part of the equation was not where the problem was: “the important thing to ask is not whether the volume of money (M plus M’) is greater, but rather what is the new relation between MV plus M’V’ and the volume of goods coming to market.”[30] What was much difficult to establish than the scale of monetary expansion was both how the new liquidity affected the velocity of money and to what sectors of the real economy it was channeled. To answer these questions, it was necessary to look at the state mechanism of control of capital accumulation and to what usage that capital was put. In other words, to answer the question about the possibility of inflation, reliance on economic theory alone was not sufficient. There was no question that the means of deficit finance applied were inflationary in principle, but it was impossible to determine when and how strongly this fact was going to manifest itself. “In our discussion of prices we shall see that only with the greatest difficulty, and with limited success, was the urge to higher prices resisted by means of laws and decrees.”[31] Poole’s conclusion was thus that it was the tenuous grip of state control that held inflation in check rather than “any newly discovered deviation from the usual phenomena of a normal recovery”[32].

Poole was of an opinion that the effectiveness of price controls, among which wage freeze and limitations on the volume of consumer credit were of major importance, was a matter of confidence rather than either economic theory or state policy. He evoked the experience of the 1923 hyperinflation to explain the underlying logic of that phenomenon.

“For with the present German psychology money in circulation is an important indicator of the danger of inflation. It is for this reason that official commentators have minimized the importance of whatever increase in Reichsbank notes has taken place, pointing out that some rise in money in circulation is to be expected with reviving business activity.[33]

The success of price control measures was rooted not merely in the allocation of the newly produced liquidity in the state-controlled armament sector and not in the potentially inflationary consumer sector, but in the creation of confidence among all market participants that the Mark was not going to lose its value no matter what happened.

In the final analysis, Poole believed that the scope of the Nazi market-manipulative strategy was constrained in some way by economic laws, in which he differed from later wartime authors. That strategy was extremely effective until “the rise in money in circulation had not reached sufficiently great proportions to furnish a basis for fears concentrating the possibility of currency inflation. The tremendous rise in that year [1938] cannot, however, be ignored. This […] constitutes a radical change in the situation.”[34] The problem for an economist was to predict when that constraint was going to be reached. Furthermore, because there were so many non-economic, or in Poole’s words – extraneous, factors at play, he concluded that “we are likely to remain for some time in the dark with respect to the precise worth of public works as an instrument for stimulating a continuing form a private investment; a multitude of extraneous factors prevent the attainment of laboratory conditions.”[35]

1. The wartime consensus

German Economy 1870-1940 was the first comprehensive study of the German / Nazi economic history which appeared after the outbreak of war. It was written by an Austrian economist Gustav Stolper who immigrated to the US in the 1930s and published his work there. The book can be summarized as a tale of ascendancy of the German state over what Goering called “the so-called free economic forces”[36] with the grand finale in 1933. Stolper emphasized the ideological distinction between ‘creative’ and ‘rapacious’ capital:schaffendesand raffendes Kapital. “Creative capital is essentially industrial capital; rapacious capital is finance and trade capital. The rapacious capital, so the National Socialist saga goes, has conquered all the power in modern society and subjected the people to interest slavery.”[37] This distinction was used by the Nazis to argue that the employment of new liquidity was overwhelmingly productive in nature; the increased output will more than compensate for it and therefore there was no source from which inflation could emerge. According to Stolper, this distinction was merely a rhetoric device used to disguise the real cause behind keeping inflation in check – the power of state control.