Up to this point, this book has dealt exclusively with the history of economic policy in West Germany, i.e. in one of the two separate states which had emerged from the ashes of the German Reich after the Second World War. Because of the virtual absence of economic exchanges between the eastern and the western part of the divided country from 1945 to late 1989, comparatively small East Germany has hardly been worth mentioning at all in this context. In late 1989, however, the peaceful revolution in East Germany paved the way for the most joyful event in the history of twentieth-century Germany: economic and political unification. West Germany's currency and its economic order were introduced in East Germany on 1 July 1990; political unification followed shortly afterwards, on 3 October. Since then, the devastating heritage which the demise of the Soviet-type command economy had left behind in the East has become a major challenge and concern for economic policy in the new Germany. In the following three sections, we shall briefly summarize what the heritage of the communist command system was for the East German economy by the time when the Berlin Wall came down (Section 1), how economic unification between the two German states was actually carried out and which consequences it had in the short run (Section 2), and what will be the long-run prospects of the eastern German economy in a re-united country (Section 3).

The heritage of a command system

In the aftermath of the Second World War, Germany – and Europe – had been divided into a communist East and a democratic and market-orientated West.

At least in its first five chapters, this book has told the story of a fading miracle. The main economic messages of this story may be summarized as follows:

1. (i) After three dismal years of central administration by the Allied authorities, the West German economy was subjected to a shock therapy of radical monetary reform and price liberalization. This combined treatment proved extraordinarily successful: it unleashed supply-side forces and allowed for a very fast reconstruction and a thorough structural adjustment of the economy's productive potential within about two years. Because of the strict stability orientation of monetary and fiscal policy, an initial surge of corrective price inflation could be kept at bay without any major macroeconomic disruptions.

2. (ii) In the 1950s, the early momentum of reconstruction became a genuine growth miracle. Given the ample supply of highly mobile and well-trained surplus labour, the only temporary impediment to high growth and the reduction of unemployment was the shortage of capital. This could be overcome mainly through high business profits, which were heavily favoured by tax exemptions to give firms the financial leeway to carry out the necessary investment projects, despite a still very narrow capital market. Foreign aid – notably US aid through the European Recovery Program – was only of minor economic importance for the process of capital formation, although it may well have been a very important political indicator for the American presence in Europe, which raised private investors' confidence in political stability and thus facilitated the reintegration of West Germany into the world economy.

3. […]

For Germany and all other countries liberated from the Nazi dictatorship, the end of the Second World War created the opportunity for a better beginning. In the following three years, the newly gained freedom of the German people already manifested itself in an intense political debate and a vigorous cultural life, at least in those parts of the former Reich now occupied by the Western Allies. At the same time, however, the standard of living fell to a dismally low level, far worse even than the economic hardship endured at the height of the hostilities. In the memory of Germans who lived through these days, it is not the war itself but the three years after which have become deeply engrained as the time of hunger and misery when even the Catholic Archbishop of Cologne publicly encouraged his flock to go on stealing the food and the coal they needed to survive the winter. In early May 1947, the food rations issued in major industrial centres of Western Germany were down to 740–800 calories per day, i.e. roughly one-quarter of the pre-war consumption of 3,000 calories. And while industrial production in the rest of Western Europe already exceeded its 1938 level by 7 per cent in 1947, West German factories still churned out no more than 34 per cent of their pre-war output. There was hardly any hint of an economic miracle to come.

For most industrialized countries of the Western hemisphere, the 1960s and early 1970s were a golden age, with economic growth reaching its post-war peak. For West Germany, things look slightly different. As to unemployment the situation was very healthy, since a state of full or over-full utilization of the country's stock of capital and labour could be preserved for about one and a half decades – interrupted only by one major sharp recession in 1966/7. As for economic growth, however, the period looks more like a time of transition from the economic miracle of the 1950s to normal international standards and – from a historical perspective – to the secular growth slack of later years. The same holds true for the more qualitative category of structural change: while the economy still relied heavily on the successful export engine which had been at the heart of the German miracle in the 1950s, the need for structural adjustment away from the export orientation was increasingly felt all over the period.

That West Germany's economic transition went along with a gradual sociological and political transformation may be more than sheer historical coincidence: step by step the paternalistic conservatism of the Adenauer years gave way to a mixture of liberal openness and tolerance in lifestyle and a new wave of socialist thinking in intellectual discourse.

On 18 October 1952, a British weekly published a survey on the performance of the West German economy since the Second World War. Its general message was plain: unconditional acknowledgement of a wholly unexpected economic recovery, the so-called German miracle, and warm praise for the sound economic policies that had brought it about. On 15 October 1966, the same paper carried another survey of this type called ‘The German Lesson’, in which the acknowledgement and praise of fourteen years earlier had become a quite enthusiastic – although not uncritical – celebration of the virtues of an export-orientated economy German style, with its excellent industrial relations and its reasonable macroeconomic policies. For all occasional caveats, West Germany appeared as a shining counter-model to the Britain of the day, with its economy inflicted by sclerotic diseases and maltreated by macroeconomic stop-and-go shocks. On 7 May 1988, about six weeks before the fortieth anniversary of the West German currency reform, the same paper published a leading article on the state of the West German economy. Under the highly suggestive headline ‘Wunderkind at 40’ and below a front cover showing a fat middle-aged man, unmistakably German in appearance, the article conveyed the picture of a rich, saturated and stodgy economy with not much zeal for growth and not enough flexibility for structural change left over from the days of its youth; the prospects for the future were painted in somewhat gloomy colours, and there was no talk any more of an enviable German model.

The year 1973 marks a watershed in the economic history of most industrialized countries: for at least one and a half decades to come, economic growth did not recover its prior speed, and unemployment became a persistent rather than a merely cyclical feature of the macroeconomic picture. For West Germany, the time after 1973 was a particularly bitter period of awakening: until the early 1970s, the country had been spared any major economic crisis, and the only sharp recession, in 1966/7 – albeit frightening – had seemingly been cured with a strong dose of Keynesian medicine. Although everybody knew that the happy days of the German miracle had passed long ago, the macroeconomic performance – especially the state of overemployment – still looked quite satisfactory by the international standards of the day. Clearly, warning voices from academia could be heard early on, but the public was not yet ready to listen. All this changed dramatically after 1973: as all could now see, West Germany gradually turned into a laggard in the international growth race, with the lowest real GDP growth of the six largest industrialized countries. While the unemployment record remained better than in most other economies of Western Europe, the shift from general labour shortage in the 1960s and early 1970s to chronic labour surplus thereafter was very disquieting.

In the following two sections, we shall ask which economic forces can be held responsible for this change for the worse, and what economic policy did about it in the past and could do about it in the future.

For most of the time in the twelve years after the currency reform, the development of the West German economy turned out to be a virtually unqualified success, with fast growth, tolerably low price inflation, a rapidly declining level of unemployment and an increasingly secure external balance. In the following two sections, we shall ask why this was so and, in particular, what contributions economic policy made to this apparently miraculous performance. For expository convenience, we shall deal separately with matters of the domestic and the international realm (Sections A and B respectively).

Overcoming capital shortage and unemployment

By late 1948, most independent observers agreed that the liberal reform of June 1948 had initiated a quite dramatic revival of the West German economy, with production soaring well above even the most optimistic expectations and inflation soon running out of steam. With the reform having basically succeeded, the policy debate took a slight turn away from the abstract philosophical issue of the vice or virtue of a social market economy to the more pragmatic question of whether the early expansionary momentum could be transformed into a sustainable non-inflationary process of cumulative supply-side growth at a full utilization of the economy's productive potential, above all the rapidly growing labour force. With the benefit of hindsight, it is clear that the following period of 15 to 18 months – a time of consolidation, if not of slight recession – was to become decisive in this respect. Therefore, this period deserves careful examination, both as to its actual economic development and as to the most exciting and paradigmatic policy debate which it brought about.

This book is an essay in applied economics, not in economic history. To be sure, history is its subject matter, but the main interest of the authors – all of them economists – was to describe and evaluate a long chain of events in the light of their own economic understanding. Hence, the book is addressed above all to students of economics and interested laymen, not necessarily professional historians who would like to learn new facts about West German post-war economic history. The reader we have in mind should be familiar with the basic tools of economic reasoning and should have a keen interest in history; no more is required.

Reality can hardly be understood unless it is deliberately simplified by abstraction. We had to abstract from numerous facts and relationships that others might have wished to stress. Admittedly, the choice is subjective: idiosyncrasies may have come in, though we tried to avoid them. No doubt, Marxists would have seen things through different conceptual glasses. But we believe that our ‘individualistic approach’, which regards markets rather than classes as the decisive force of economic history, yields a quite consistent interpretation of actual events, at least in the case of West Germany since the Second World War.

In our view, the main lesson comes down to one fundamental proposition: miracles emerge when spontaneity prevails over regulation, and they fade when corporatist rigidities impair the flexibility for smooth adjustment.

Historians and economic historians have long wondered what accounts for the systematic differences between French and English agriculture. These differences encompass not only productivity, where it has long been recognized that British agriculture was superior to that of other preindustrial European countries, but also institutions. While recognizing that the determinants of agrarian achievement are complex, this chapter uses a theoretical model to argue that different legal institutions explain the divergence in the agrarian histories of France and England. As we have seen, institutions played a significant role in blocking investment in water control in Old Regime France. Here we explore how British institutions promoted one of the most dramatic features of agrarian development – the conversion of wasteland to farmland. One important way to reclaim waste and increase usable acreage was to drain marshes, a process that in England began before the seventeenth century and continued past the eighteenth. In France, by contrast, little drainage occurred before the Revolution.

As we have already seen, although marshes were most often called wastes, they played an important role in the rural economy. In low-lying areas, marshes were used by villagers for pasturing their animals and gathering forage and reeds, as well as for fishing. Villagers used the marshes as part of their commons, but they did not necessarily own the marshes. In fact, both the village as a community and the lord of the village had rights to the marsh. Even if the lord was most often the ultimate owner of the marsh, he could not always make unilateral decisions about its drainage. Indeed, authority over drainage was a complex legal issue.

Under the Old Regime, drainage and irrigation were stymied by litigation over property rights that dragged on for decades. Most of the courts, like the parlements or the conseil in which suits over water control were argued, were supposed to be final courts of appeal. Despite repeated claims of final and expeditive justice, however, the courts continued to hear appeals; hence, it is clear that they reneged on their promises of speedy trials. The courts did not keep their promises because they were not bound to honor their announcements.

As we shall see, kings, courts, and private individuals frequently announced future plans of action and later chose not to follow those plans. The inability of many actors in pre-Revolutionary France to commit to future plans dramatically increased transaction costs in some sectors of the economy. Solutions to problems of inconsistent announcements, although well known before 1789, were never effectively implemented under the Old Regime. In contrast, the governments that followed the Revolution steadfastly abided by contracts. More important, after 1800 the state forced other organizations to keep their promises as well. This chapter presents an investigation of the problems of commitment under the Old Regime in three areas that proved crucial to the development of water control: litigation, royal granting policies, and water rights.

To uncover the logic behind the actions of Old Regime organizations, let us examine the case of judicial officers in greater detail. Since civil litigation was quite costly in monetary terms, justice should have been prompt and appeals should have been discouraged unless they had good cause.

In the early Middle Ages, improved land was scarce and unimproved land abundant. As a result, lords and villages chose different property rights to govern these two types of land. Property rights to improved land were precisely assigned, giving rise to what we call private property. In contrast, it was not worthwhile to define property rights to unimproved land clearly, for enforcing such rights would have required monitoring unwarranted by the low value of the land. Thus, unimproved land fell under a regime of common rights. This system was efficient as long as it was possible to improve land when relative prices shifted. Yet poorly defined property rights would come to stand in the way of improvements in general and water control in particular. In order to earn a return on their land improvement schemes, water control projectors had to divide costs and benefits between themselves and the owners of the land. Carrying out such a division required an agreement on existing property rights (establishing who owned the marsh) as well as agreement on a rule that translated the original distribution of property rights into a share of the profits (benefits minus costs). Presumably, marshes could have been improved and still remain common. However, in the eighteenth and nineteenth centuries it was generally thought that development was incompatible with common rights. To complicate matters, by the year 1700, altering property rights from common to private required state approval. Hence, the regulation of common land that had begun largely as private contracts between medieval lords and their serfs had become a public institution.

The importance of adequate drainage for agricultural productivity is well known. In Old Regime France, drainage could have significantly increased agricultural output on two areas. First, in many regions of France, fields already under the plow would have greatly benefited from increased water control. Second, as we have seen in Chapter 4, drainage played a crucial role in bringing new land under production. Between 1700 and 1850, draining fields already under the plow presented a complex institutional problem because it required reallocating customary, common, and private property rights at once. In the case of marshes, the problem was more modest, since only customary and common rights had to be altered. This chapter focuses on the problems associated with draining marshes in a specific area: lower Normandy in northwestern France (see Map 1.1). The climate and geography of lower Normandy make it ideal for a study of drainage because it endures both steady rainfall and inadequate natural drainage over a large proportion of its terrain. More specifically, within lower Normandy the area most in need of drainage was the Dives Basin (Map 6.1). The basin had originally been almost all marsh, but in the Middle Ages abbeys had spearheaded settlement and drainage, yet in the eighteenth century, much land still remained poorly developed; these lands are the focus of our first detailed study of the interaction between institutions and drainage.

The Dives Basin lies on the coast of the English Channel in Normandy, only a few miles east of Caen in the department of the Calvados. It corresponds roughly to the present canton of Troarn and is a very flat plain with small hills.

Eighteenth-century French agriculture is often portrayed by historians as shackled by institutional and technological constraints. The countryside was littered with the remains of the feudal regime, and these institutional encumbrances stood in the way of modern market-oriented production techniques. In 1789 the high winds of revolution swept through rural France and shook it violently. For some scholars the tempest of 1789 blew the remains of the feudal regime into oblivion and created a new economic and social order. Others have argued that by 1820 few traces of the storm remained: The French rural world was still hopelessly backward compared with its modern British counterpart. The turmoil of the Revolution had been for naught; only the slow process of urbanization and technological change could relieve the problems of the French countryside.

This book investigates specific sectors of agriculture in France – irrigation and drainage – to document both the costs of Old Regime institutions and the consequences of reforms carried out during the Revolution. In an effort to clarify the connection between institutional reform and economic change, the study uses the methodologies of social science both in its treatment of quantitative evidence and in its explicit use of formal economic models.

In order to make both historians and economists comfortable, I begin in Part I not only by summarizing the relevant historical debates, but also by presenting the economic models that will be used in the analysis. Part II of the book comprises four chapters. First, I provide evidence about the extent of drainage and irrigation efforts between 1700 and 1860 at the national level.