The development of economic ideas

The first German university chairs in cameralism were created at Halle and Frankfurt an der Oder in 1727, and by the late eighteenth century nearly every German and Austrian university had followed suit.

With the disruptions of the French Revolution and French invasions of the Holy Roman Empire, profound changes were imposed upon the German lands which made much of Staatswirtschaft obsolete. The single most influential economic thinker in the German states in the first two decades of the nineteenth century was Adam Smith, and his idea of an unfettered division of labor came to be understood as Nationalokonomie (national economy) and/or Volkswirtschaft (people’s economy), both of which were synonymous with the English term “political economy” in the classical sense.

The backlash against French occupation, the upheavals of the Napoleonic wars, and the anxieties over ongoing German disunity after 1815 did fuel considerable nationalist criticism of the cosmopolitan orientation of Adam Smith’s political economy, most prominently in Friedrich List’s Nationale System der Politischen Oekonomie (1841). However the analytical basis of List’s critique of Smith drew almost exclusively on American sources that List had studied over his many years in the United States, notably Alexander Hamilton. The growth of German nationalism in the first half of the ninteenth century was also marked by an intense interest in the national past which culminated in the formation of the modern discipline of history in Germany (Leopold von Ranke). This “historicism” would have a profound impact on both the study of law (Friedrich von Savigny and Karl Eichhorn) and the field of political economy for the remainder of the nineteenth century, finding its way into the curriculum of Staatswissenschaften through the most influential textbook of the time, Wilhelm Roscher's System der Volkswirtschaft (1854).

It is customary to distinguish between an “older” and “younger” German historical school of political economy, the older of which included — in addition to its leading figure, Wilhelm Roscher — Bruno Hildebrand and Karl Knies. While Roscher was inspired by the application of historical method to law, in his work history was used merely to illustrate classical economic theory and not as a new economic method per se.

In the 1850s and 1860s the impulse for more statistical work in political economy came from the various statistical bureaus in German states, most notably those in Saxony and Prussia. The director of the Royal Saxon Statistical Bureau, Ernst Engel, made one of the major discoveries in economics (1857) by observing that the share of the household budget spent on food rose as household income fell. Conversely, as household income rose, a smaller relative share of the household budget was spent on food, even as expenditure on food increased in absolute terms. This relationship, which became known as Engel's Law, was one of the first functional economic relationships ever discovered using quantitative techniques, and as such, its discovery marks the beginnings of econometrics (Engel's Law and Engel curves are today a fundamental part of microeconomic price theory).

Major advances in laboratory science at the time in numerous fields such as physics (Hermann Helmholtz), chemistry (Justus Liebig), and medicine (Rudolf Virchow), as well as the Darwinian revolution unfolding in biology, lent great credibility to empiricism in economics, for which history and statistics seemed the most closely approximate tools. Indeed, so powerful were these natural scientific models that an empirical, descriptive, and statistical orientation tied closely to practice (i.e. policy) would predominate in all of German Staatswissenschaften for the next 50 years, of which the “younger” historical school was but one, if the most influential, strand.

The “younger” historical school went further in rejecting the universal claims of classical political economy to also criticize its inadequate psychological foundations and misuse of abstract deduction.

The priority given to statistics and economic history by members of the historical school over the development of general economic theory was not without criticism. One of the sharpest of these was launched by the Austrian economist Carl Menger in his Untersuchungenuber die Methode der Socialwissenschften (1883). While the resulting dispute between Menger and Schmoller was ostensibly over the best economic methodology, strong personal animosities overshadowed the dispute from the very beginning and drew artificial lines between empirical-statistical research and analytical-deductive theoretical work which proved to be sterile and counterproductive over the longer term.

While the historical school remained very influential in Germany up until the First World War, it should not be overlooked that many other prominent German economists of the nineteenth century continued to embrace deductive theorizing and worked to refine classical political economy, some of whom took it in directions which would anticipate twentieth century neoclassical economic theory. Economists who worked in this vein included Karl Heinrich Rau, Hermann Heinrich Gossen, Friedrich Hermann, Karl Knies, and H.K.E. von Mangoldt. Carl Menger's work in developing a neoclassical theory of value based on subjective valuation (marginalism) introduced in his Grundsatze der Volkswirtschaftslehre (1871) was strongly indebted to many of these predecessors, most notably Rau, Hermann, and Mangoldt. Likewise, it has been shown that Heinrich Gossen anticipated William Stanley Jevons' work in this direction in Britain by many years. Other German economists who continued to work using classical and neoclassical theory before the First World War included Albert Schaffle, Adolph Wagner, Johannes Conrad, and Heinrich Dietzel, though in their work the empirical and encyclopedic orientation toward political economy typical of this time can certainly also be seen. Two important milestones in the work of organizing and systematizing economic knowledge were the Handworterbuch der Staatswissenschaften (8 vols. 3rdedn. 1910) and the Grundriss der Sozialokonomik (9 vols. 1914-30).

Another major strand of German economic thought not tied to the historical school is Raumwirtschaft (the economics of space).

Following Germany's defeat in the First World War and the experience of catastrophic hyperinflation in 1923, much (though not always deserved) blame was placed on members of the “younger” historical school for having abandoned economic theory, this allegedly having led to economic mismanagement and leaving Germans ill-equipped to face the profound eco­nomic dislocations and challenges of the postwar period. In any case, the 1920s were a time when German economics as a discipline became self-consciously more international and when methodologies were much in flux. One example of this was the success of new foreign textbooks, notably Gustav Cassel's Theoretische Sozialokonomie (1918), which by 1932 had gone through no fewer than five German editions. As another indicator, the Austrian theorist Joseph Schumpeter was called to a prominent chair in economics at the prestigious University of Bonn in 1925 and spearheaded important reforms in teaching, methodology, and research focus, thus helping to bring Germany closer to the international mainstream.

Given the economic disorder of the 1920s and early 1930s, business cycles became one of the most active areas of research in the Weimar Republic. Particularly prominent in this field was Ernst Wagemann, who headed the Reich Statistical Office as well as the state-sponsored Institute for Business Cycle Research. Wagemann's significance to the history of economic thought is tied to his early development of an equation of exchange that amounted to a circular flow of aggregate economic activity in which the value of production equaled production costs and profit, which in turn was equivalent to total national income. In other words, there are strong indications that Wagemann developed the rudiments of national income accounting in Germany and must be counted alongside Keynes as one of the fathers of macroeconomics. German location theory and the economics of space also developed rapidly after the First World War and began to exercise greater influence on German urban and regional planning during the Weimar Republic and under National Socialism. Of those working in this area during this time was the economic geographer Walter Christaller, who developed what would become his influential “central place theory” to explain the economic hierarchies between towns and cities. This would later provide a template for Nazi plans to systematically resettle and develop annexed territories to the east.

In the 1930s∕40s a group of German liberal economists around Walter Eucken, Franz Bohm, and Hans Grossmann-Doerth at the University of Freiburg were alarmed by the legacy of hyperinflation and the many other examples of arbitrary state intervention in the economy during the Weimar and Nazi years. They committed themselves instead to restoring a liberal free market system with a strong legal and institutional framework to sustain a competitive economic order and individual freedom. Though the influence of these “Ordo-Liberals” on postwar German academic economics was limited, they did influence Chancellor Konrad Andenauer and the first West German Economics Minister, Ludwig Erhard, who established an independent central bank and a hard currency, and engaged in limited countercyclical demand management via fiscal and monetary policy. West German economic policy and particularly the policies of the Bundesbank, were guided by these Ordo-Liberal ideas for much of the postwar era.

By contrast, American and British economic thinking dominated postwar German academic economics, which was defined in many ways by the reception of the Keynesian-neoclassical synthesis in macroeconomics, a steady formalization (mathematization) of microeconomic theory, and the introduction of probability theory in econometrics. The most important figure in the reception of Anglo-American economics and leading light in the discipline in the immediate postwar period was Erich Schneider, who was later made director of the influential Institut fur Weltwirtschaft (Institute for the World Economy) at the University of Kiel in 1961. His textbook Einfuhrung in die Wirtschaftstheorie (1947—9) was widely used to train postwar economists in West Germany.

For much of the postwar period, Kiel was the leading center of empirical research and “free- market” economic policy thought, with a particular focus on the analysis of structural change led for many years by Herbert Giersch, who succeeded Schneider in 1969. The University of Bonn, by comparison, developed a reputation for working on the theoretical frontiers of microeconomics with very high levels of formalization. Reinhard Selten, who taught there for many years, shared the 1994 Nobel Prize for his contributions to game theory. Selten was also a pioneer in experimental economics. Two other important postwar centers of research emerged at the Universities of Mannheim and Cologne. Mannheim developed strengths in general equilibrium theory and time series analysis, while Cologne became an important center for empirical work tied closely to policy at its Institut fur Wirtschaftspolitik (Institute for Economic Policy). This was due in no small measure to the strong ties that developed between its faculty and federal ministries in Bonn. The Verein fur Socialpolitik continued to function as the professional body of academic economists, and most of the German economic journals that were founded in the ninteenth century continued publication in the postwar period.

Postwar German economic research was also shaped by the plethora of “acronym” research institutes funded by state and federal government agencies, employers’ organizations, private firms, and foundations. Among the more influential of these was the Ifo-Institut in Munich, the ZEW in Mannheim, the IW in Cologne, the DIW in Berlin, and the HWWA in Hamburg. Much of this research focused on economic growth and the business cycle.