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What is to be done? The German Economic Miracle


People ask me all the time to nominate at least some potential winners to take South Australia’s economy out of its present economic tailspin.

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The truth is that nobody knows what these winners will be. There are lots of ideas and beliefs (including my own), but most of them will be wrong.

People, especially politicians and public servants, who support particular solutions to our problems, are all guessing.

If I knew for sure what the winners would be, I would not let on. As the late (and great) inspiration of the Liberal Party’s “Dries”, Bert Kelly, MHR,  would say, I would invest in them myself and spend the rest of my life in the South of France with my feet in a bucket of champagne.

What economists like me do know is what the discovery process is that leads to finding the winning investments and businesses that we all want.

That process is trial and error. The more trials that take place, the more winners that will be discovered.

What we need is more and more people having a go – becoming entrepreneurs. Most of these imaginative and courageous people will lose their stake. But some will not. The successful few will attract emulators, competitors, suppliers and users in new, fast-growing industry clusters.

After a while the economy will be transformed.

The real question, therefore, is how to stimulate business start-ups and trials and rapid expansions of young businesses – how to stimulate entrepreneurship.

The evidence is in, and there is a big literature on it.

The advice that flows from the evidence has fallen on deaf political ears in South Australia, because it takes us in the opposite direction to that which we have been comfortably following for a long time.

The answer is: smaller government, lower taxes, less business regulation and freer labour markets. These changes will not only encourage more start-ups and new industries, they will also help existing businesses to expand by cutting their costs.

The quid pro quo is that government spending must be cut. Cutting government spending provides additional expansionary impetus when the costs of the activities being cut exceed their benefits.

For example, the large bureaucracies in health and education are largely unnecessary: hospitals, clinics, surgeries, schools and training centres do not need central supervision and direction to meet the targets that are prescribed for them. These bureaucracies should be significantly cut and the savings used to cut taxes and/or State Government debt.

There are four major pieces of evidence supporting this economic revival program that I shall review in this and future articles:

Let me start with the West German economic miracle after WWII.

Germany lay in ruins at the end of WWII in 1945, but within 20 years West Germany was at the top of the European economic league tables.  From 1953-1963 West German Gross National Product grew by 6.7 per cent p.a., compared with 4.7 per cent p.a. in France and 2.7 per cent p.a. in the UK. West Germany’s performance in industrial output and exports was phenomenal.

Yet, for the first few years after the end of the war, the West German economy went nowhere. Price-fixing, rationing, black markets, barter and a worthless reichsmark produced ruinous economic results. Full employment was maintained only by a system of planning and controls that produced many goods that nobody wanted. The economists advising the Allied Occupation powers were largely Keynesian and broadly sympathetic to economic planning.

Ludwig Erhard (later West German Chancellor) used the establishment of the new deutschmark in 1948 to secure the immediate lifting of a whole range of price and other controls, allowing the market to operate freely. There was a sharp cut in income taxes. For a West German with an average income the marginal tax rate fell from 85 per cent to 18 per cent.

There was an immediate economic response, with industrial production increasing by more than 50 per cent and per capita income rising by over 14 per cent. High growth rates were sustained over the next 15 years.

Famous Harvard economist, John Kenneth Galbraith, a Keynesian economic adviser to the US Military Government, was sceptical about Erhard’s liberalisation program.

He commented: “There has never been the slightest possibility of getting German recovery by this wholesale repeal [of price controls], and it is quite possible that [it] has delayed Germany’s recovery.”

Subsequent events showed Galbraith to be spectacularly wrong.

Much research on the issue has confirmed that the dramatically-fast West German economic recovery did result from the removal of the planning and price controls installed by the Allies (along with the remnants of the Nazi command economy). Moreover, this shift in economic policy was without the consent and against the wishes of the occupying Allied powers.

Subsequent studies inspired by West Germany’s remarkable economic achievement imply that liberalising a government-dominated economy (like South Australia’s, for example) could yield an addition to the annual growth rate of South Australia’s Gross State Product of about 1.5 per cent p.a..[i]

If so, a thorough liberalisation of South Australia’s economy along West German post-war lines could double South Australia’s economic growth rate and take South Australia’s economic growth above Australia’s as a whole. Assuming an acceleration of productivity growth to 2 per cent p.a., this would lead to the creation of 8,000 extra jobs a year in South Australia, instead of our present situation where no extra jobs have been created over the past five years.

Richard Blandy is an Adjunct Professor of Economics in the Business School at the University of South Australia.

[i] J.D. Gwartney, R.A. Lawson, and W. Block, Economic Freedom of the World: 1975–1995, Fraser Institute, Vancouver, 1996.

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