Reassessing the dependence of capitalism on democracy – the case of Imperial Germany and the Weimar Republic

Summary of JOIE article (First View, 20 January 2020) by Gerhard Wegner, Lehrstuhl für Institutionenökonomie und Wirtschaftspolitik
Staatswissenschaftliche Fakultät, Universität Erfurt. The full article is available on the JOIE website.

Recent approaches in institutional economics emphasize the dependence of capitalism on democracy. Acemoglu/Robinson (2012) argue that only inclusive political institutions will establish inclusive economic institutions which make sure that all members of society have equal access to economic rights such as property rights, the freedom of trade or the freedom to choose an occupation. Once political institutions exclude groups or individuals systematically from political participation, those in power will control economic institutions in order to obtain rents via economic privileges. Likewise, North/Wallis/Weingast (2008) argue that “Limited Access Orders” stabilize themselves insofar as an elite group or “dominant coalition” exercises political power and thereby establishes a stable order. In exchange for this political function it grants itself economic privileges and controls economic competition on its own behalf. If one equates economic institutions which guarantee equal economic rights with capitalism, the latter depends on general political participation or democracy. While Acemoglu/Robinson argue more straightforwardly that democracy is both a necessary and sufficient condition for capitalism and therefore causes democracy, North/Wallis/Weingast are more careful in postulating a causal relationship. However, they also argue that capitalism and democracy, once established, will form a “double balance”. As an implication, an “open access order” cannot regress into a “limited access order”.

There are good theoretical reasons as well as empirical support for this intimate relationship between capitalism and democracy. However, our understanding of the developmental path to an open access order and its stability requirements is still too rudimentary.. The case study of Imperial Germany and the Weimar Republic is devoted to providing further insights that may extend beyond the individual case. So far contributions in institutional economics have neglected the German case which is interesting for many reasons.

During the 19th century the formerly agrarian, German economy developed into a center of modern capitalism within a few decades after having established capitalist institutions in terms of equal economic rights. But Imperial Germany, even though it was not an autocracy, lacked full parliamentarianism. While it was one of the first European countries to introduce universal male suffrage on the federal state level, the imperial government was appointed by the emperor. On the subnational level, class voting systems were widespread. However, the unusual political order consisting of a constitutional monarchy which itself consisted of constitutional monarchies, Duchies and Grand-Duchies proved to be supportive of the new capitalist order. The constituent states retained much of their economic autonomy, in particular as far as taxes and public goods are concerned. Since the Tariff Union as well as the the constitution of 1871 formed a common market and guaranteed the free movement of goods, labor and capital, the political order gave rise to what Weingast termed “market preserving federalism”. During the period of the North German Confederation (1867 – 1871), political liberalism, which was well represented in parliament, was the driving force in completing the institutional foundations of a market order in alliance with the conservatives. Legislative proposals in the North German Federation set the South-German states under pressure to follow suit with the liberalization of the economy. The capitalist economic order essentially remained intact until the Great War, including in foreign trade relations. The views expressed by Hayek, Mises and others that the economic order turned towards interventionism, protectionism or even organized capitalism overstate some of those tendencies and fail to describe the order accurately. 

Furthermore, the domestic liberal market order was complemented and safeguarded by an international economic order based on the most-favored nation clause and moderate free trade, while protectionist tendencies remained limited, all the more so in comparison with the interwar period. 

Strikingly, the lack of full parliamentarianism supported  the stability of the competitive order. Due to equal voting rights on the level of the federal state, opponents of capitalism gained the majority in parliament. Socialist and the Catholic Center (albeit for different reasons) rejected capitalism and sought to overcome capitalism. The reluctance of parties which represented the bourgeoisie and burgeoning middle class is better interpreted as a rational choice: There was no gain from full democracy. The liberal economic order was guaranteed while the constitutional monarchy offered sufficient political participation rights, as the growing significance of the Reichstag testifies.

The move towards full democracy after the Great War removed the institutional anchors of capitalism in Germany. First and foremost, democracy changed the balance of power between capital and labor. In principle, the economic order itself was at stake. Even though markets remained the predominant form of coordination, the new political order offered many opportunities to influence entrepreneurial decisions or even to nationalize companies. Wage settlements were also politicized. Accordingly, the employers’ associations complained about the new “Union State”. Even though Social Democrats, unlike the split Communist Party, did not strive for a planned economy, it aimed to transform the capitalist order into a mixed economy. This disoriented entrepreneurship, which now preferred short term investment strategies and the erection of market barriers including cartels in order to protect profits. Accordingly, Eucken complained about the anti-competitive, bureaucratic spirit of German entrepreneurs who were markedly different from their predecessors’ willingness to take risks.

Significantly increased state expenditure ratios, higher tax rates and lower investment ratios characterized the Weimar economic order. The collapse of the international economic order combined with reparation payments added to the destabilized domestic economic order. Hence, the politicization of the domestic economic order went hand in hand with politicization on the international stage. 

The limited capacity of democracy to find a way out of the economic crisis became a formative experience for ordoliberal economists such as Eucken and Böhm. It turned out that stability, predictability and investment-friendly taxes and regulation were hard to realize in democracy, notwithstanding the justifiability of social policy objectives. The search for a solution of this trade-off would become a dominant topic of German economic policy. To conclude, the inter-war period offers a lesson that inclusiveness of institutions is a necessary but not a sufficient condition for self-stabilization of capitalism and democracy. 

References

Acemoglu, D. and J. Robinson, (2012), Why Nations Fail. The Origins of Power, Prosperity, and         Poverty, New York: Crown.

Eucken, W. (1932), ‘Staatliche Strukturwandlungen und die Krisis des Kapitalismus‘,   Weltwirtschaftliches Archiv, 36: 297-321. Reprint in ORDO (1997) 48: 5 – 24.

North, D. C., J. J. Wallis and B. R. Weingast (2009), Violence and Social Orders. A Conceptual         Framework for Interpreting Recorded Human History, Cambridge: Cambridge University         Press.

Weingast, B. (1995), ‘The Economic Role of Political Institutions: Market Preserving Federalism and           Economic Development’, Journal of Law, Economics and Organisation7(1): 1–31.

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