A good starting point for understanding the historical contours of German economic thought is the fact that Germany as a modern nation-state only came into being in 1871, so that much of the history of the German lands was defined by disunity and particularism.
This created a variety of universities and encouraged a plurality of approaches to the discipline of economics. Until 1866 Austria, along with Prussia, was one of the most important influences upon the other German states and so must be considered in any survey of the cultural, administrative, and business traditions that shaped German economics.
In the eighteenth century German economics grew out of Staatskunst (statecraft) into Staatswirtschaft (state economy), an administrative discipline that had evolved alongside the needs of enlightened absolutist rulers, the political order that defined the courts of Austria, Prussia and many of the lesser German states following the catastrophe of the Thirty Years War (1618—48). As such, it was a field preoccupied with the practical administrative needs of the court, namely management of royal domain lands, forests, mines, and military and luxury industries, as well as royal finances. While many of the German states were open to new economic ideas coming from the French and Scottish Enlightenments, notably the ideas of Du Pont, Mirabeau, Quesnay, Turgot, and especially Adam Smith, the political, social, and economic conditions in Germany (estate order, guilds, remnants of serfdom) made their application difficult until the Napoleonic invasions and the modernizing reforms they forced on the German states, most prominently the Stein-Hardenberg reforms in Prussia after 1807.
Even as Adam Smith's ideas began to inform German understandings of the economy as an autonomous component of civil society, the administrative legacy of cameralistic Staatswirtschaft remained prominent in modern German conceptions of economics. As such the economy, even an ostensibly free economy, was conceived as something ordered by law and institutions and requiring administrative guidance. Inspired by Smithian ideas, Prussian civil servant reformers introduced a liberalization of customs and tolls (1818) and then the German Customs Union (1834),which enabled a national division of labor among the German states for the first time and which would later spur the rapid industrial development of Germany in the 1850s and 1860s.
Under Prussian leadership the North German Confederation (1867—71) and German Empire (1871—1918) introduced freedom of navigation on inland waterways, a modern commercial code,
uniform weights and measures, a common currency, and a central bank. Even before unification, various competing German states had developed outstanding systems of public education that assured near universal literacy by the early nineteenth century, and individual states invested heavily in systems of vocational, technical, and higher education, including major polytechnic schools and research universities that conducted cutting-edge applied and theoretical research in the natural sciences. The state also played a key role in developing and administering the system of universal health, accident, and old-age insurance pioneered in Germany in the 1880s.
Beyond the important role of state and federal governments, other key institutions in the German economy have been universal banks, employers’ organizations, and trade unions. Germany's rapid industrial development in coal, iron, steel, railroads, machinery, chemicals, and electrical equipment meant that banking institutions emerged which combined the functions of commercial and investment banks in order to pool deposits into direct lines of credit and raise the needed investment capital by underwriting bond and stock issuance for very heavy investments in plant and machinery. The so-called “D-banks” (large joint-stock banks so named because they happened to have names starting with the letter D: Darmstadter Bank, Deutsche Bank, Disconto-Gesellschaft, and Dresdner Bank) not only lent directly to firms but also often became their major shareholders and subsequently took an unusually direct role in advising business strategy and guiding long-term investments.
German employers, who faced a literate, organized, and increasingly social democratic workforce, were quick to organize themselves into employers’ organizations (Arbeitgeberverbande) which negotiated with organized labor to avoid disruptive striking and lobbied their interests to government.
A similar process of interest organization and advocacy also emerged in the agricultural and handicrafts sectors. Cartels and syndicates in such industries as iron, coal, and chemicals became a notable feature of this uniquely German form of “organized capitalism,” a development often encouraged by the close ties between banks and firms. Partly to escape the strictures of cartels and partly to gain the scale economies needed in certain industries to reduce unit costs, many German firms developed a strong export orientation, often in highly specialized niches where they would come to hold monopolies or near monopolies, a strategy that defines the German Mittelstand, the medium-sized, family-owned firms that form the backbone of the German economy to this day.Even with such powerful institutions as stabilizers in the German economy, economic policy was highly contentious and saw frequent breakdowns in the twentieth century. The Revolution of 1918 and the Weimar Republic gave organized labor a prominent political role, a time which also witnessed catastrophic hyperinflation and an expanded welfare state. This sparked a backlash from employers and conservative politicians during the Great Depression that enabled the rise to power of the Nazis. Hitler came to power at a time of ruinous deflation and unprecedented mass unemployment in 1933. He violently “coordinated” organized labor and then mobilized Germany’s prodigious industrial resources to rearm and launch a war for Lebensraum (living space) in the east, which Hitler and the Nazis imagined would solve Germany’s social and economic problems once and for all. Instead, total war and genocide followed, culminating in the devastation of much of Germany and Europe.
With the birth of the Federal Republic in 1949, a more durable economic policy consensus formed which managed to balance the legitimate claims of both organized labor and employers, a consensus that enabled a stable currency and internationally competitive firms while also sustaining heavy investment in infrastructure, education, housing, and social services.
This mix of policies, commonly referred to as soziale Marktwirtschaft (social market economy), has not always been uncontested, but it has been flexible enough to survive stagflation in the 1970s and the challenges of German reunification in the 1990s. Remarkably, most of the key institutional features of German capitalism (with the exception of cartels) remain in place in reunified Germany today, despite two destructive world wars and Cold War division in the twentieth century. Heavy investment in R&D, high levels of technical skill, and a strong orientation toward quality remain defining features of the modern German industrial economy. That said, the traditional focus on investment (producer) goods means that the consumer economy, the service sector and newer industries like IT have been somewhat starved of investment and lag behind in competitiveness. Consumer credit is likewise remarkably underdeveloped in Germany, and labor participation rates for women are comparatively low. With barriers to entry in most sectors high due to trade and employers’ organizations, rather rigid systems of vocational and professional certification, and the dominant position of powerful banks, not much of a tradition of active entrepreneurship and venture capitalism has yet developed in Germany. Most employment in the German private sector today is in older firms pursuing long-term investments in established product markets.