German "Ordnungstheorie". From the Perspective of the New Institutional Economics

Richter, Rudolf Article German "Ordnungstheorie". From the Perspective of the New Institutional Economics Schmollers Jahrbuch – Journal of Applied Social Science Studies. Zeitschrift für Wirtschafts- und Sozialwissenschaften Provided in Cooperation with: Duncker & Humblot, Berlin Suggested Citation: Richter, Rudolf (2012) : German "Ordnungstheorie". From the Perspective of the New Institutional Economics, Schmollers Jahrbuch – Journal of Applied Social Science Studies. Zeitschrift für Wirtschafts- und Sozialwissenschaften, ISSN 1865-5742, Duncker & Humblot, Berlin, Vol. 132, Iss. 4, pp. 473-500, https://doi.org/10.3790/schm.132.4.473 This Version is available at: https://hdl.handle.net/10419/292382 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ German “Ordnungstheorie” From the Perspective of the New Institutional Economics* By Rudolf Richter Abstract German “Ordnungstheorie”(~ system theory, ordo theory) relates essentially to Walter Eucken (Freiburg) who attempted to strike a balance between the economics of the German Historic School, still relevant in Germany of the 1930s, and its opposing neoclassical analysis. The paper starts, therefore, with a brief description of Eucken’s morphological approach, his “isolated abstraction,”as an analytic method that is focusing on a precise description of the institutional framework of the analysed economy with only vague assumptions on human wants, behaviour, behavioural constraints etc. Its considerations may be loosely compared with the strategic reasoning of lawmakers who are primarily interested in the general consequences of their draft bills and not in (theoretically or econometrically established) predictions of their effective functioning. Marginal analysis is abandoned and replaced by general behavioural assumptions such as “… all normal men everywhere and at all times act in accordance with the economic principle.” Target of Eucken’sOrdnungspolitik (ordo policy) is to minimize (measurable market) power instead of striving for (immeasurable) Pareto efficiency. Eucken’s morphology, his ideal typical description and ordering of institutional frameworks by way of “isolating abstraction,”may be seen as a predecessor of Williamson’s formation and use of “efficient governance structures.”Eucken’s questioning of the regulative ability of laissez faire anticipates (instinctively) the consequences of Olson’s logic of collective actions. Eucken, together with the other members of the Freiburg school, demand from the state the establishment and guarantee of an economic constitution of a free market economy based on David Hume’s principles of natural law: private property, freedom of contract and personal liability. This paper continues with a neoinstitutional discussion of Eucken’sordo-liberal principles of Ordnungspolitik, which served as basis of the West German Wirtschaftswunder after the currency reform of 1948. It ends with a critique of Eucken’s deliberations and some reflections on Douglass North’s“adaptive efficiency” as another substitute for the empty concept of “Pareto efficiency”. Schmollers Jahrbuch 132 (2012), 473 –500 Duncker & Humblot, Berlin Schmollers Jahrbuch 132 (2012) 4 *Paper presented at the 15th annual meeting of the International Society for New Institutional Economics, June 16–18, 2011, Stanford University, USA. –My thanks for critical comments go to an anonymous referee, and to Günther Hönn and Dieter Schmidtchen (both Saarbrücken) for their valuable discussion of earlier versions. OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.132.4.473 | Generated on 2023-01-16 13:36:42 Zusammenfassung Was wir in Deutschland unter „Ordnungstheorie“verstehen, geht im Wesentlichen auf Walter Eucken zurück –auf seinen Versuch, den Widerspruch zwischen der Deutschen Historischen Schule, die im Deutschland der 1930er Jahre noch eine Rolle spielte, und der Neoklassischen Wirtschaftstheorie zu überwinden. Der Aufsatz beginnt mit einer kurzen Beschreibung des morphologischen Ansatzes von Eucken, seiner Methode der „pointierend hervorhebenden Abstraktion“, als einer Forschungsmethode, die –im Gegensatz zur Neoklassik –ihr Hauptgewicht auf genaueste Beschreibung des institutionellen Rahmens der zu analysierenden Wirtschaft legt und sich dafür mit vagen Annahmen über die wirtschaftlichen Bedürfnisse und Beschränkungen der Einzelnen begnügt. Die starken Annahmen der Grenznutzenschule werden ersetzt durch allgemeine Verhaltensannahmen wie, „dass alle Menschen –soweit sie geistig gesund sind –stets und überall nach dem wirtschaftlichen Prinzip handeln“(1947, 344). Ziel der Ordnungspolitik Euckens ist die Minimierung (meßbarer) Marktmacht statt das Streben nach (unmeßbarer) Pareto Effizienz. Euckens Morphologie, seine Beschreibung und Strukturierung der institutionellen Rahmenbedingungen vermöge der Methode „pointierend hervorhebender Abstraktion“, lässt sich als Vorläufer von Williamsons Behandlung „effizienter Governanz Strukturen“verstehen. Mit seiner Infragestellung des Erfolgs einer Politik des laissez faire antizipiert Eucken die Konsequenzen der Olsonschen Logik des kollektiven Handelns. Deshalb verlangt Eucken, wie die übrigen Mitglieder der Freiburger Schule, die verfassungsrechtliche Sicherung der Regeln oder Ordnung einer freien Marktwirtschaft, die den von David Hume beschriebenen drei klassischen Grundsätzen genügt: Privateigentum, Vertragsfreiheit und persönliche Haftung. Es folgt eine Diskussion der Grundsätze der Wirtschaftspolitik Euckens, die dem westdeutschen Wirtschaftswunder von 1948 ff. zugrunde lagen. Den Schluss bilden kritische Anmerkungen zu Euckens Ausführungen und zum Konzept der „Anpassungseffizienz“, das Douglass North als Ersatz für das leere Konzept der Pareto Effizienz vorschlägt. JEL Classification: B25, B31, B52, L16, L22 Received: 12 February 2011 Accepted: 01 October 2012 Ordnungstheorie (~ system theory, ordo theory) and New Institutional Economics have opposing objectives: The objective of Ordnungstheorie is the “… scientific understanding of real economic life”1, given the institutional framework (economic system or “order”) within which economic life happens, while the objective of the New Institutional Economics2is the economic analy- 474 Rudolf Richter Schmollers Jahrbuch 132 (2012) 4 1Eucken (1950, 221). 2The term “New Institutional Economics”was introduced by Williamson (1975) and became a standard (or banner) under which a diverse group of economists assembled, who shared one common intellectual ground not only that institutions matter (as in what became “constitutional economics”) but that the determinants of institutions can be analysed with the aid of economic theory –taking into account transaction costs, incomplete foresight and bounded rationality. A different (at first sight possibly more obvious) way OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.132.4.473 | Generated on 2023-01-16 13:36:42 sis of the institutional framework of the economy itself (its “order”). That is, in spite of their different objectives, the two approaches have one common point of interest: the institutional framework of economic life. For that reason it may be of interest to neoinstitutionalists to have a closer look at German Ordnungstheorie. A warning in advance: To translate Eucken’s thoughts into to-day’s economic language –and do him justice –is the task of a historian of economic thought, which we are not. We discuss therefore in this paper Eucken’s theory as we see it. 1. Introductory Remarks German “Ordnungstheorie”, together with its application as “Ordnungspolitik”, relate essentially to Walter Eucken (1940) and his criticism of the at his time in Germany still relevant economics of the Historic School of Gustav Schmoller (1900) and its consequences, viz., the infamous Methodenstreit between the German Historic School and the Austrian Theoretical School of economics as represented by the work of Carl Menger (1883). Eucken assumes an intermediate position between German historic and Austrian theoretic approach. This is one reason why Eucken’sFoundations of Economics is so tedious to read for modern economists. Another reason is that Eucken belonged to the at that time large group of German “verbal”economists, who were either hostile or strongly reserved to the application of mathematical methods in economics (at that time largely differential calculus) because mathematics would belong to the natural sciences while economics is a humane discipline (see Stackelberg, 1948, X). Still, Eucken applies some concepts of “mathematical” economics such as demand and supply curves, Cournot’s monopoly theory, Stackelberg’s oligopoly theory, the concept of marginal costs. But he uses no utility function, no marginal value theory, and no Pareto optimality, i.e., Eucken keeps clear of value theory, the prevailing economic theory of his time.3In- stead, he suggests using a mix of historic and theoretical analysis that he calls morphological approach (Eucken, 1940, 1950, 293). In the subsequent German literature the term Ordnungstheorie established itself. This method describes an economy from aspects of its outside appearance, viz., from its type of economic system or “order”(like “centralized economy”or “exchange economy”), as well as from aspects of form and structure of its internal organization (like its market forms or type of monetary systems). The morphological approach is to be seen in contrast to a “physiological”explanation of economic life, i.e., the explanation of functional issues (as does neoclassical microeconomics or Key- German “Ordnungstheorie”475 Schmollers Jahrbuch 132 (2012) 4 to deal with Ordnungstheorie is in terms of Buchanan’s (1987) “Constitutional Economics”as is illustrated by Vanberg (1988, 2005). 3That culminated in Hicks (1939). OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.132.4.473 | Generated on 2023-01-16 13:36:42 nesian macroeconomics). Its aim is to explain –or predict –the consequences of the general organizational structure of an economic system, not to explain – or predict –the actual level or development of specific economic magnitudes such as interest rates, commodity prices, unemployment etc. Thus, for the morphological approach suffice very general information on human wants, behaviour, knowledge, constraints etc. It may be compared with the strategic reasoning of lawmakers who are interested in the general consequences of the draft bills they are voting on and not in (theoretically or econometrically established) predictions of their detailed functioning Correspondingly, Eucken proceeds in general terms. He describes an economy as a system of actors whose actions “… are always based on an economic plan.”4Economic behavioural assumptions are only briefly mentioned, such as that “… all normal men everywhere and at all times act in accordance with the economic principle”. (Eucken, 1950, 293). How actors proceed in detail depends on “spiritual and intellectual characteristics of individual men in different periods, classes or nations”(loc. cit. 294). Human actions are constrained by the givens (“data”). Eucken apparently disagreed with the unhistoric methodology of “pure economic theory”, i.e., its mathematical method of constrained individual utility maximization. Hence, he does not use the concept of Paretooptimality to assess economic systems or “orders”. Instead, Eucken applies the concept of economic power,5which became an object of dispute between adherents of the Marginal Utility School (“pure economic theory”) and the Historical School in the early 1900s.6Its issue was, how to explain income distribution: by the “natural laws”of marginal utility analysis or by means of the social concept of “power”. However, Eucken does not deal with distributional aspects. He refers to the general aspect of human freedom, viz., that power confronts men and politics with the dilemma that the possession of power provokes arbitrary actions, endangers the freedom of other people, and destroys mature and good institutions. Nevertheless, without the possession of power there can be no social life; for there must be authority –in the state and in a firm. (Eucken, 1952b, 38) Eucken continues that economic power would reach its maximum concentration in the totally centralised economy7and its minimum in an exchange econo- 476 Rudolf Richter Schmollers Jahrbuch 132 (2012) 4 4Eucken (1950, 117 f.). 5Which has many facets. Eucken’s attempts to clarify it: 1950, 263 and Note 59. 6Debated was the relevance or usefulness of marginal productivity theory for the explanation of real world income distribution. Böhm-Bawerk (1914) defended in a wellknown paper Austrian marginal utility theory against Stolzmann (1909) who argued that it is power alone that determines the distribution of income. 7“… in the central authority, which alone formulates economic plans and controls the actions of all the members of the community, who for their part are left without power or freedom.”(Eucken, 1950, 265). OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.132.4.473 | Generated on 2023-01-16 13:36:42 my,8to wit, under conditions of perfect competition on all markets.9But in this context “economic power”is merely a specific type of power, viz., “market power”; or more precisely: the power to admit/exclude someone to/from a market and to make/take prices.10 Of course, Eucken disapproves of centralized economies.11 He opts for an exchange economy with perfect competition, i.e., a market economy with an entirely functioning price mechanism. To achieve such an economy, economic life would have to be controlled by an appropriate norm system or “order”whose development must not be left to laissez faire but should be designed and enforced by the state in accordance with a catalogue of constitutional norms. This catalogue has been suggested by Eucken (1952a), in apparent accordance with the other members of the Freiburg School like Böhm. He argued that what matters is the quality of the design of the constitution or order of the economy and its defence by the force of law (Böhm, 1937, 106). We’ll describe first Eucken’s conceptions of Ordnungstheorie and Ordnungspolitik as we see them and then continue with a neoinstitutional discussion of his views. Some analytic remarks and inferences are following. An afterword concludes this paper. 2. On Eucken’sFoundations of Economics The German Methodenstreit reached in Germany into the 1930s. An important topic was Schmoller’s demand that before one starts to draw general conclusions from a set of underlying assumptions these have to pass the test that they truly are the crucial causes of the economic phenomena in question (Schmoller 1883, 245). That would be the “stricter”(strengere) form of science (Schmoller, 1894, 538). All other forms of theorizing would be “premature” and should be avoided. By contrast, Eucken argues: The theoretical questions do not come at the end of our science, and the theoretical propositions, which we have to seek, are not simply a distillation of experience. (Eucken 1950, 40 f.). German “Ordnungstheorie”477 Schmollers Jahrbuch 132 (2012) 4 8Eucken (1950, 269). 9That is probably what Eucken (1950, 205) calls “complete general equilibrium”or the “static state of the Lausanne School”, i.e., what we now call “general equilibrium”. 10 Schmoller (1906) vividly illustrates this aspect of economic power. 11 As for the “centrally administered”economy, “… because of the size of the community and the number of goods to be valued, it is impossible to express the values of goods in quantitative terms …[and] as history shows, economic calculation, and therewith any precision in the control of the economy, encounters the greatest difficulties.” (Eucken, 1950, 119, 120) “Men have experienced the extraordinary disadvantages that are related with centralised planning.”Eucken (1952a, 118 f.). OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.132.4.473 | Generated on 2023-01-16 13:36:42 The economic process goes on always and everywhere within the framework of a historically given economic system (or order) (Eucken, 1950, 80). However, his theoretical approach –a morphological approach –differs crucially from that of neoclassical economics (marginal utility approach). It demands a precise description of the “outside”appearance of an economic system or order (Eucken, 1950, 89). For this purpose, he suggests to apply the concept of an “ideal type”in the following sense: The individual features of an individual phenomenon …are extracted and ideal types built up out of them. …The method of “isolating”abstraction or of abstraction of the distinguishing or significant characteristics12 starts from the individual fact. (Eucken, 1950, 107)13 Such ideal types “are …to be used as ‘models’on the basis of which theoretical propositions can be worked out (1950, 233). Note that Eucken’s ideal types differ from Weber’s who describes his ideal type as a thought up “Utopia”, which is “… to be contrasted and compared with actual economic conditions.”14 Against this, Eucken’s morphological ideal types are got the other way round –from the actual economic world –to help us understand it. In fact, they would be completely indispensable “… for an understanding of the structure of actual economic systems, that is for one of the central problems economics has to solve.”They finally “… help us to understand both the nature of different economic systems and that of the economic process, that is, the whole field of economic reality”(loc. cit. 173). Thus, “… the knowledge of the different kinds of systems (of Wirtschaftsordnungen) is the first step towards knowledge of economic reality”(Eucken 1950, 90). Eucken’s“ideal types”might be seen as “clinical cases”: A special real world case is assigned to its respective ideal case (or “ideal type”)–the sum of its outstanding properties –like that of the market forms of monopoly, duopoly or perfect competition etc. …15 Williamson (1985, 79) proceeds in a similar fashion by use of his types of efficient governance structures such as “unified governance”,“bilateral governance” etc. As mentioned above, Eucken distinguishes two extreme cases of ideal types: the centrally directed economy and the exchange economy. Between them are numerous types of mixed economic systems, so that we have a whole catalogue 478 Rudolf Richter Schmollers Jahrbuch 132 (2012) 4 12 By applying “the method of ‘isolating’abstraction, or of abstraction of the distinguishing or significant characteristics“that starts from the individual fact –in contrast to the “generalizing”abstraction with which the constructors of “stages”or “styles”of development work (Eucken 1950, 107). [“Pointierend hervorhebende”oder “isolierende” Abstraktion (Eucken, 1947, 114)]. 13 A good summary of Eucken’s views on these matters provides Schmidtchen (1984, 57 f.). 14 See, e.g., Weber (1968, 6). 15 See Eucken’s list of “forms of market”(1950, 158). OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.132.4.473 | Generated on 2023-01-16 13:36:42 of morphological schemes of different ideal types of economic systems with numerous different features. Of particular interest for us is the general system of an exchange economy, described by Eucken as an open or closed system16 of interrelated markets of various forms,17 combined with some monetary system (1950, 156 ff.). Eucken’s ideal types of an exchange economy are determined by (1) a set of “data”that comprise individual needs, the stock of already produced goods, land and natural resources, technical knowledge, legal and social organization; 18 (2) a set of empirical rules or “laws”,19 of which Eucken lists Gossen’s First Law, the law of diminishing returns, and the law of productivity of “roundabout”production; and (3) the presence of “risk”.20 Of particular interest for the neoinstitutionalist are Eucken’s comments on the “datum”of legal and social organization. It is here where Eucken’sOrdnungstheorie and the New Institutional Economics overlap. Eucken is convinced “… that the modern industrialized world does not of itself produce an effective economic system, but requires certain controlling constitutional principles as a foundation”that are to be issued and guaranteed by the state.”(loc. cit. 315)21 Legal thought and practice would to an increasing extent have the task of co-operating with economists in the design and implementation of the norms of this economic constitution. Beyond question, Eucken’s morphological theory tends more into a “historic-legal”direction than into one of “pure economic theory”that became neoclassical microeconomics. Unsurprisingly, Eucken’s ideas attracted the interest of German legal scholars. Thus, Eucken and two law professors at his University of Freiburg, viz., German “Ordnungstheorie”479 Schmollers Jahrbuch 132 (2012) 4 16 “Supply and demand are ‘open’if every individual or group has access to the market as supplier or demander, and if each individual can supply or demand whatever quantity he thinks fit.”(loc. cit. 134). 17 Such as competition, oligopoly, monopoly either on supply or demand side or both, with open or closed markets (loc. cit.158). 18 Eucken (loc. cit.178 ff.). 19 loc. cit. (loc. cit.186 ff.). 20 Loc. cit. 198 ff.; Eucken mentions at the sidelines Knight (1921), thus his term of “risk”might have included “Knightian”uncertainty. 21 According to Hutchison (1979, 433) there are two modes of arguments for free markets: a “Smithian”and a “Ricardian”. The latter would be also followed by some “neoclassical.”It is derived from an abstract, purely economic model of competitive equilibrium …”, while the Smith mode is formulated in much broader terms,“…comprehending the political and social order, and especially the legal foundations and framework of the economic order.”The ideas of Eucken’sOrdnungstheorie and Ordnungspolitik follow this Smithian mode. OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.132.4.473 | Generated on 2023-01-16 13:36:42 Franz Böhm and Hans Großmann-Doerth, established in 1936 a series of publications entitled Ordnung der Wirtschaft. The series was opened by Böhm (1937)22 with a paper on “The Design of Economic Order as Historic Task and Law Creating Achievement”. In contrast to Hitler’s actually practiced policy, Böhm argued that the economic constitution in force at that time [1937] would still provide for a free market economy, and continues That implies our responsibility to restore the normative character of the constitution of a free market in its highest possible purity and to do the utmost to restore the normative character of a free market constitution in best possible purity and to do one’s utmost to encounter (oppose) the cult of soft law (Kult des Faktischen), even in cases where markets are still free, to help win the economic constitutional way of thinking (Böhm, 1937, 71). He supports the idea of a liberal economic constitution understood as a legally protected system of competitive markets. His paper is an outspoken attack on fascist corporatism that was increasingly practiced in Germany of that time. Böhm, Eucken, Großmann-Doerth together with another Freiburg economist, Leonhard Miksch (1937), became known as the founders of the Freiburg School of economic thought –whose ideas were soon dubbed ‘Ordoliberalism’. It is to be seen as a counter movement against the widespread German centralist, anti-bourgeois and anti-liberal trends of the time between the wars and thereafter.23 3. On Eucken’s“Principles of Economic Policy” Given Eucken’s reservations towards pure economic theory (marginal utility theory) and maintenance of his interest in historic-legal characteristics, “efficiency”(like Pareto-efficiency) of economic systems is not his problem (a welcome attitude from the perspective of the NIE). Instead, he is interested in the social issue of the control of power through price competition. Therefore, and not for efficiency reasons, Eucken favours the market form of perfect competition. To work properly, competition requires an economic constitution (“order”) whose formation cannot be left to laissez-faire. Rather, design and administration of the economic constitution is the task of economic policy or “Ordnungspolitik”by the state. However, the state should not intervene in the economic process itself.24 480 Rudolf Richter Schmollers Jahrbuch 132 (2012) 4 22 The first issue appeared behind issues 2 and 3. 23 On the intellectual movements of the 1920 th and 1930 th see, e.g., Kiesel (2007, Vierter Teil). 24 See Eucken (1950, 314, 1952a, 336); similarly Eucken (1952b, 95f.): “The state should influence the forms of economy, but not itself direct the economic process. […] State planning of forms –Yes; state planning and control of the economic process – OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.132.4.473 | Generated on 2023-01-16 13:36:42 In addition, the executive board of the central bank must be made up of people who have the reputation of standing for stable money, and who are not at any price ready to jeopardize their reputation. The purchasing power promise is then enforced –so the theory goes –by the threat of money users to destroy the reputation of the members of the central bank’s executive board. They would do this by unleashing a hyperinflation through their refusal to use the central bank’s money.47 Doubts can be raised,48 though we’ll stop here. Anyway, our presentation reveals the wide gap between Eucken’s institutional demands for stable money and that of modern, in a sense, institutional economic theorists. (3) Eucken’s (264 ff.) principle of open markets is directed against public and private impediments of the price mechanism. This principle appears to be a plausible norm of competitive pricing. However, resource allocation takes place not only on markets, controlled by the price mechanism, but also within firms, controlled by decree. Thus, the decision to produce some good is preceded by a “make or buy”decision, i.e., by the decision to make the good yourself within your firm or to buy the good on the market. In other words, the foundation or the size of firms becomes an issue. As Coase (1937) had shown and Williamson (1985) specified, firms may be resource saving alternatives to markets. Which organizational mode (firm, market or anything in between) is preferable depends on the actual levels of transaction costs, Knightian uncertainty and the limits of human rationality. Anyway, from aspects of the new institutional economics, it is impossible to rate barriers to trade prima facie as economically unwelcome impediments of the price mechanism. Interjection on the following three constitutional principles of private property, freedom of contract, personal liability: They correspond to the three “fundamental laws of nature”, which are, according to Hume ([1739–40] 1969, 578), “… that of the stability of possession, of its transference by consent, and of the performance of promises.”According to the doctrine of natural rights, who provided the basis for classical economics, man is seen as a selfish creature.49 Taking this into account, above three principles can be seen as the elements (incentive structure) of a social-economic control system or “order”that coordinates the allocation of resources within a society of selfish people by means of individual self-interest.To- German “Ordnungstheorie”487 Schmollers Jahrbuch 132 (2012) 4 47 There is an extensive literature on this topic. In addition to Kydland/Prescott (1977), there are the works of Barro/Gordon (1983), Blackburn and Christensen (1987), Persson/Tabellini (1990) among others. For a survey see Persson/Tabellini (1990). These are works of the “new classical macroeconomics”, according to which in the short-run, despite the hypothesis of rational expectations, room remains for monetary stabilization policy. We announce our doubts about this approach. 48 Richter (2002). 49 Who “loves himself better than any other single person, and in his love of others bears the greatest affection to his relations and acquaintances”(Hume [1739–40] 1969, 539). OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.132.4.473 | Generated on 2023-01-16 13:36:42 gether with the institution of money such an individualistic control system is a method to overcome the shortcomings of positive transaction costs, limited foresight (Knightian uncertainty) and bounded individual rationality –the three basic assumptions that distinguish NIE from neoclassical microeconomics. (4) The principle of private property (in material and immaterial goods)50 unfolds its social control function only if sanctioned ownership rights are transferable by consent and in accordance with the principle of freedom of contract. Central insight of property rights analysis is that under the conditions of NIE51 the allocation of property rights to selfish individuals (the “owners”of resources who are following the economic principle52) gives them not only an incentive to handle their allotted (“owned”) resources parsimoniously but navigates their use also into the macro economically right direction. Eucken continues: Only under conditions of perfect competition do both, owners and nonowners, profit in the institution of private ownership.53 Thus, as private ownership in resources (“means of production”) is a precondition of a competitive order (Wettbewerbsordnung) as is a competitive order a precondition of avoidance of economic and social grievances due to private ownership in resources. Therefore: Private ownership of the means of production demands its control by competition (Eucken, loc. cit. 275 –own translation; emphasis added). The principle of private property cannot be too highly praised. It forms the basis of human self-determination –described by John Locke as “property in one’s own person”.54 (5) The principle of freedom of contract means inter alia that the individual has the right to contract the transfer of property rights with a freely chosen partner in a mutually binding agreement. It supplements the principle of private property in an essential way insofar as it allows individuals to use their specific knowledge (“not given to anyone in totality”Hayek 1945) to adapt to unforeseeable events that would be uncontrollable (or very costly to control) by central decision-making. Actually the principle of freedom of contract, just as that of private property, reveals its relevance as an instrument of social control only under conditions of the NIE. Eucken (1952, 275 f.), who highlights the work- 488 Rudolf Richter Schmollers Jahrbuch 132 (2012) 4 50 Understood in the sense of full ownership. 51 Among them information costs due to which knowledge is “not given to anyone in totality”(Hayek 1945). 52 Eucken (1950, 281). 53 Because: “In the state of perfect competition [Eucken means: in general equilibrium] are private owners of firms in an equilibrium of economic power”(Eucken, 1952, 274). In microeconomic terminology: The state of general equilibrium is Pareto efficient –a term not used by Eucken. 54 The relevant sentence is: “Every man has a property in his own person. This nobody has the right to but himself”(Locke [1823] 1963). For further interpretations see Furubotn and Richter (2005, 91 f.). OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.132.4.473 | Generated on 2023-01-16 13:36:42 ing of the price mechanism, emphasizes its role as precondition of competition. His argument that the principle of freedom of contract can be (and actually is) used to form coalitions with the purpose to restrain competition (Eucken, 1952, 48), implies the assumption of positive transaction costs. In such a world the constitutional state (Rechtsstaat) must protect its citizens not only from the coercive power of government but also from arbitrary acts by other citizens.55 Insofar, Eucken can conclude: […] it has become obvious that the modern industrialized world does not of itself produce an effective economic system, but requires certain controlling constitutional principles as a foundation. […] Legal thought and practice will to an increasing extent have the task of co-operating [with economics] in the building and establishing of the economic constitution. (Eucken 1950, 315) One should add, at least after the financial crisis of 2008, that the principle of freedom of contract allows also the creation of “financial products”that are prone to above mentioned Lemons Principle, i.e., to market collapse –an object of public interest that demands public measures (given positive transaction costs), as do monopolistic practices. (6) The principle of personal liability relates to the concept of contract, which according to common law is a commitment to act later.56 Debtors should not promise more than they expect to be able to fulfil. The principle of personal liability, therefore, is supposed to invoke trust in future actions of the promisor. Anyway, it commits the promisor. If the debtor doesn’t live up to his promise, the creditor (promisee) may sue him to get access to his wealth. The social control function of the principle of personal liability springs from the incentive for the debtor to act judicious. Differently expressed, personal liability is a device for forcing actors to internalize the social cost of their actions. “Limiting liability can thus be seen as subsidizing risky behaviour and allowing some actors to externalize part of the costs of their actions.”(Carney, 1999, 665). Eucken (1952a, 280), whose central interest is the working of the price mechanism, emphasizes that the principle of personal liability impedes the merger of firms in their “thirst for power”. It therefore would strengthen the formation German “Ordnungstheorie”489 Schmollers Jahrbuch 132 (2012) 4 55 “If the constitutional State (Rechtsstaat) was able to protect its citizens from arbitrary acts of the State itself, it was unable to save them from the arbitrary acts by other citizens”(Eucken 1952, 52). Eucken warns that the constitutional state is only able to succeed completely if together with its public legal order an “adequate”economic order is realized (52). 56 Following Llewellyn (1931–32, 708): the term “contract”understood as “the legal effects …of promises”. Time is involved in an essential way –as opposed to the language of the German Civil Code according to which contract is “a juristic act [Rechtsgeschäft], normally consisting of two declarations of will [Willenserklärungen]”(Horn/ Kötz/Leser 1982, 74). OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.132.4.473 | Generated on 2023-01-16 13:36:42 of a competitive order (Wettbewerbsordnung) and help make the competitive process effective. He states, “Without personal liability a competitive order becomes just as little functioning as without adequate market forms and monetary orders.”(1952a, 280 f.). He observes skeptically the enormous increase of the number of corporate bodies “during the last decennia”, and with it the decline of the importance of personal liability. Limited liability rules “… would promote concentration of firms and impair the functionality of the price mechanism.”57 They would greatly contribute to the evolution of business mergers and monopolistic practices and impair the working of the price mechanism (ibid.). However, Eucken disregards that, because of incomplete foresight (Knightian uncertainty), not all risks can be shifted through the market wherefore Arrow (1970) concludes …the failure of the market to achieve adequate risk-shifting leads to compensatory alterations on social institutions, licensing, bankruptcy and limited liability, and large business organizations. But all of these institutions are steps away from the free working of the price system …[and] all the institutions …decrease the flexibility and responsiveness of the system to change and innovation. (loc. cit. 141) Of course, interruptions of the ‘natural’capitalist control mechanism –i.e., its control by the price mechanism –has to be bridged by some appropriately designed non-market control mechanisms (organization) like corporations, corporate boards, securities and exchange commissions, financial regulators, bankruptcy courts, the judiciary in general, etc. However, Eucken distrusts such non-market control mechanisms.58 To be noted, in this context, is that Eucken, as most economists of his time, dealt with price theory only on the basis of spot markets and their equilibrium, as illustrated by the ‘Marshallian Cross’. Futures markets are left out, and thus financial markets –like bonds and stock markets. However, it is in particular here where the problem of liability arises, and where Akerlof’s Lemon Principle emerges. It supports Eucken’s demand for a publicly designed order (a collective good) such as of public supervision of asset markets and the application or threat of legal coercion.59 The unpleasant results of a laissez faire policy are illustrated, i.a., by the consequences of the financial crisis of 2008.60 490 Rudolf Richter Schmollers Jahrbuch 132 (2012) 4 57 Eucken (1952a, 281). 58 Eucken (1952a, 281 ff.). 59 See also Böhm (1937, 106). 60 One such moral hazard was that banks, instead of holding loans on their balance sheets, changed to an ‘originate and distribute’model. ‘They repacked loans and passed them on to various other financial investors, thereby offloading risk’(Brunnermeier, 2009, p. 78). In doing so, banks created ‘structured’products –collateral debt obligations (CDOs) consisting of diversified portfolios of mortgages and other types of loans – sold in private placements with confidentially agreements. Banks then sliced these port- OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.132.4.473 | Generated on 2023-01-16 13:36:42 The existence of incomplete foresight (Knightian uncertainty) can in principle be allowed for (and are in fact regarded) by the design of workable organizations that bridge the gaps in the chain of personal liabilities and thus try at least to mend the self-enforcing mechanism of a liberal market economy. One has to accept that, in a world of incomplete foresight, the price mechanism has its limits. The principle of constancy of economic policy makes sense only for Eucken’s economic constitution of the real part of the economy,61 not of its monetary system for which he demanded a once and for all fixed automatism. As for the rest he allows for changes of the institutional framework. However, if order-political measures are chasing each other the borderline between Ordnungspolitik and Prozesspolitik becomes blurred. Too frequent changes of norms are in effect not much different from Prozesspolitik and would disturb the functioning of the price mechanism and hamper investment planning. 5. Retrospective and Inferences As was mentioned at the beginning, it is not easy to translate Eucken’s ideas in to-day’s economic language and do him justice. We’ll try to do our best by discussing our expositions of Eucken’s ideas under two aspects: Firstly, from a political-economic point of view, as an economic policy program against a strong anti-liberal, anti-civil movement and its outfall since 1933 and after; Secondly, from an analytical point of view, as an attempt to describe (or understand) the economic process morphologically, i.e., from its “outside”, its institutional framework or “order”, within which it occurs. On political-economic aspects: Eucken’sOrdnungstheorie is characterized by its emphasis of and trust in the price mechanism (control of demand and supply by price competition), given an adequate economic constitution, and its distrust in a laissez fair development of an adequate economic constitution or “order”. As a direct consequence, Eucken wants the state to enact, implement and administer an economic constitution whose norms agree with above-de- scribed constitutional principles. Given the enactment of such an economic constitution (Wirtschaftsordnung) and its administration by Ordnungspolitik “… economic power [will] disappear[s] completely”(Eucken, 1950, 269), where “economic power”means “market power”or the power to admit/exclude someone to/from a market and to make/take prices. German “Ordnungstheorie”491 Schmollers Jahrbuch 132 (2012) 4 folios into different tranches, which they sold not only to investor groups with different attitudes toward risk but also to themselves. Furthermore, buyers could also protect themselves by purchasing credit default swaps (CDSs). 61 Especially private property rights, contract law, regulation of personal liability, competition law, labor law, etc. OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.132.4.473 | Generated on 2023-01-16 13:36:42 Eucken’s emphasis of the term of “power”is to be seen against the background of the widespread belief that “… modern technology concentrates production and economic power, and that competition is doomed to vanish from modern economy.”62 Instead of the term of “economic power”, Eucken might as well have used its antonym “economic freedom”–as did his Freiburg colleague Franz Böhm a couple of years earlier. Böhm demanded the “restoration of a free market constitution in its best possible purity”(Böhm, 1937, 71). Anyway, after the West German currency reform of 1948 the ordo-liberal concept of the Freiburg School was at least partially realized.63 It served as the theoretical basis of the West German Wirtschaftswunder –in spite of the fact that the views of the Freiburg School contrasted sharply with the, at that time, most widely propagated Keynesian doctrines in Britain and, to a lesser extent, in the United States. “Therefore, most of the comments forthcoming in Britain and the USA tended to be suspicious, disapproving, pessimistic, or outright condemnatory.”Thus Hutchison (1979, 435) with interesting references to Balogh and other Keynesians. On analytic aspects of Ordnungstheorie: As indicated above, with his morphological approach –or Ordnungstheorie –, Eucken attempts to strike a balance between the (in Germany at his time predominant) historic-legal approach and its opposing purely theoretical way of thinking. The historic-legal approach deals with variable historic phenomena of economic life, it shies away from general explanations. Its considerations may be compared with the strategic reasoning of lawmakers who are primarily interested in the general consequences of the draft bills (the institutional framework) they are voting on. The opposing theoretical approach aims at a detailed prediction of the economic process as it actually takes place inside that institutional framework. Both approaches demand specific forms of “exactitude”: the historic-legal approach requires descriptive precision; the purely theoretical approach logical rigor. In Eucken’s attempt to balance these two extremes by his morphological approach, “exactitude”means a precise “isolated abstraction”(abstract replication) of the ideal typical features of an economy’s institutional framework. The economic process occurring within that framework is assumed to be driven by only vaguely described laws of economic behavior such as “… all normal men everywhere and at all times act in accordance with the economic principle.”64 In other words, Eucken’s measurement problem focuses on the precise reproduction of the institutional characteristics (the constraints of individual behavior like property rights, contracts, obligations, the structure of the monetary 492 Rudolf Richter Schmollers Jahrbuch 132 (2012) 4 62 Eucken (1952b, 41 f.); this view underlies, e.g., Schmoller’s defence of cartelization (Schmoller, 1906, 242 f.). 63 Except antitrust legislation that had been enacted later –pretty much watered down (Gesetz gegen Wettbewerbsbeschränkungen vom 27, 07, 1957). 64 Eucken (1950, 293); no reference to marginal utility theory. OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.132.4.473 | Generated on 2023-01-16 13:36:42 system, market orders etc.) and not on a detailed description of behavioral hypotheses as in standard neoclassical or Keynesian economics –and their econometric offshoots. The basic idea of Eucken’s morphological approach, his “isolated abstraction”of ideal typical features of an economy’s institutional framework, turns up (in a way) later in the form of Williamson’s“efficient governance”structures (1985, 79) or his description of the basic nature of transaction cost economics (1993, 107). On analytic aspects of Ordnungspolitik: As with regard to Eucken’sOrdnungspolitik, it is interesting to note that his constitutional principles focus on the basic principles of natural law, viz., private ownership, freedom of contract, and acceptance of obligation.65 They are the linked up parts of an ingenious social-economic control system (“order”) that coordinates in a “natural”way, i.e., by means of individual self-interest, the allocation of resources within a society of selfish people.66 It forms the basis of neoclassical microeconomics in its pure form with zero transaction costs, complete foresight and perfect rationality. Insofar, Eucken’s (1950, 269) verbal description of an exchange economy with perfect competition on all markets is quite similar to the, at his time, strictly modelled “pure spot economy”of Hicks (1946, 140).67 Here –as in Eucken (1950) –all markets are only spot markets. However, different from Hicks and other neoclassical economists, Eucken assumes simply that all decision makers act according to the “economic principle”–not enough for neoclassical micro-economists but quite agreeable with neoinstitutional economists to whom allocation efficiency (Pareto efficiency68) is a meaningless concept. The reason, why new institutional economists question the notion of allocation efficiency is that individual decision making suffers not only under positive transaction costs but also (and in particular) incomplete foresight and bounded rationality. North (1990, 80) suggests to strive for “adaptive efficiency”69 instead of allocation efficiency. He concedes, though, that …we are far from knowing all the aspects of what makes for adaptive efficiency, but clearly the overall institutional structure plays a key role in the degree that the society and the economy will encourage the trials, experiments, and innovations that we can characterize as adaptive efficient (loc. cit. 81). German “Ordnungstheorie”493 Schmollers Jahrbuch 132 (2012) 4 65 Hume ([1739–40] 1969, 542). 66 “… who find it in their own enlightened self-interest to cooperate with their neighbours in a long term relationship”(Binmore, 1992, 21). Game theorists can demonstrate that formally –under ideal assumptions. 67 Hicks’s book is listed but not referred to in Eucken (1950, note 41). 68 Defining a state of the economy in which all individuals maximize their utility under some complex set of constraints. 69 The concept of adaptive efficiency may be read as an answer to Hayek’s claim that “… the economic problem of society is mainly one of rapid adaptation to change in the particular circumstances of time and place”(Hayek 1945, 524). OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.132.4.473 | Generated on 2023-01-16 13:36:42 In his elaboration on the notion of adaptive efficiency North relates to Pelikan (1987, 29), who advocates the development of suitable organizational structures that allow, i.a., “… societies to maximize the efforts required to explore alternative ways of solving problems”(North 1990, 81). The role of the Knightian entrepreneurs70 as creative talents among decision makers of firms and other organizations comes to the fore.71 Different from Eucken, the relevant answer to the problem of rapid adaptation is not the demand of ‘more market’, such as an increase in risk shifting that may invite moral hazard (opportunistic actions of the counterparty),72 but the search for an efficacious mix of market and hierarchy as has been explained by Williamson (1985). 6. Afterword The new institutional economics is not to be seen –as frequently occurs –as a form of neoclassical economics enriched by the assumption of positive transaction costs but as something else. It is a new style of economic analysis based on the three interrelated assumptions of positive transaction costs, incomplete foresight and bounded rationality that are assumed away in neoclassical economics. Institutions are no mere means to economize on transaction costs subject to constraints –an organizational problem that would soon solve itself in the wake of to day’s rapid IT evolution. Rather, they are complex social tools to overcome the shortcomings of our limited foresight and rationality in a world of positive transaction costs and ever changing circumstances in an economically justifiable manner. Pareto efficiency, any form of constrained optimization, does not make much sense under these conditions. Rather, what matters to neoinstitutional economists is some form of evolutionary or adaptive efficiency, i.e., the capacity of individual or collective actors to adapt to unforeseen events at reasonable cost. To tackle the problem of “adaptive efficiency”, instead of defining it away, is an important, though not a simple task in our “non-ergo- dic”73 world that is characterized by ever changing circumstances (crises). The problem is how to describe the social tools that are helping to overcome the shortcomings of limited foresight and rationality in an economically justifiable manner under conditions of positive transaction costs. To ideally answer this question, it is neither sufficient to specialize on the “physiology”of economic life, given its institutional “morphology”, as done in mainstream economics. Nor is it enough to focus on the economy’s institutional framework, 494 Rudolf Richter Schmollers Jahrbuch 132 (2012) 4 70 Knight (1921, 268 f.). 71 See Richter (2010) on the role of entrepreneurs as surrogate forward traders. 72 Arrow (1970, 142 ff.) expressly points to this problem. 73 North (2005, 19). OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.132.4.473 | Generated on 2023-01-16 13:36:42 given elementary assumptions on the behaviour of actors as in Eucken’s morphological approach. Ideally, both must be analyzed: the economic system (“order”) and the economic behaviour occurring within it. That does neither Eucken by his morphological approach nor mainstream neoclassical theory and its various spin-offs. Still, Eucken’s morphological approach, his “abstraction of the distinguishing or significant characteristics”touches upon an important area that is neglected by most economic theorists. It is reminiscent of later neoinstitutional styles of reasoning –such as Williamson’s use of the concept of efficient governance structures –, whose behavioural assumptions (like that of “opportunism”) go further than the general behavioural assumptions underlying Eucken’s morphological approach. To be noted is that both institutional methods have one advantage –different from the economic analysis of law –, they put economic and legal analysis of institutions on equal footing. That is best illustrated by the close cooperation of Eucken with legal scholars at Freiburg and –to a degree –by the interest of (German) young law professors74 in the insights of neoinstitutional economics. References Akerlof, G. A. (1970): The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism, Quarterly Journal of Economics 84, 488–500. Aoki, M. (2001): Toward a Comparative Institutional Analysis, Cambridge, Mass. Arrow, K. J. (1970): Essays in the Theory of Risk-Bearing, Amsterdam. Bagehot, W. (1873/1962): Lombard Street. A Description of the Money Market, London. Reprinted Homewood, IL: Richard D. Irwin 1962. Barro,R.J./Gordon, D. B. (1983): Rules, Discretion, and Reputation in a Model of Monetary Policy, Journal of Monetary Economics 12, 101–21. Bernholz,P./Breyer, F. (1993, 1994) Grundlagen der Politischen Ökonomie, Vol. 1 (1963), Vol. 2 (1964). Binmore, K. (1992): Fun and Games: AText on Game Theory. Lexington, Mass. Blackburn,K./Christensen, M. (1987): Macroeconomic Policy Games and Reputational Equilibria in a Contracting Model, Ricerche Economiche 41, 190–209. Böhm, F. (1937): Die Ordnung der Wirtschaft als geschichtliche Aufgabe und rechtsschöpferische Leistung, Ordnung der Wirtschaft 1, Stuttgart/Berlin. German “Ordnungstheorie”495 Schmollers Jahrbuch 132 (2012) 4 74 See, e. g., contributions to various collective volumes such as Möslein (2012), Grundmann et al. (2012); or monographs like Möslein (2011), K. W. Richter (2007); and, of course, relevant contributions to the annual series of the International Seminar on the New Institutional Economics, published in the Journal of Institutional and Theoretical Economics, during the last 10 years organized and edited by C. Engel and U. Schweizer (Bonn). OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.132.4.473 | Generated on 2023-01-16 13:36:42 Böhm-Bawerk (1914): Macht oder ökonomisches Gesetz, Zeitschrift für Volkswirtschaft, Sozialpolitik und Verwaltung 23, 205–271. Reprinted by Wissenschaftliche Buchgesellschaft Darmstadt, 1975 (Page numbers of references relate to the reprint). Brunnermeier, M. K. (2009): Deciphering the Liquidity and Credit Crunch 2007–2008, Journal of Economic Perspective 23, 77–100. Buchanan, J. M. (1987): Constitutional Economics, in: J. Eatwell/M. Milgate/P. Newman, (eds.), The New Palgrave: A Dictionary of Economics 1, London et al., 585–88. Buchanan,J.M./Tullock, G. (1962): The Calculus of Consent, Ann Arbor. Carney, W. J. (1999): Limited Liability, Encyclopaedia of Law and Economics, 659– 691. Coase, R. H. (1937): The Nature of the Firm, Economica 4, 386–405. Coddington, A. (1976): Keynesian Economics: The Search for First Principles, Journal of Economic Literature 14, 1258–1373. Demsetz, H. (1969): Information and Efficiency: Another Viewpoint, Journal of Law and Economics 12, 1–22. Denzau,A.T./North, D. C. (1994): Shared Mental Models: Ideologies and Institutions, Kyklos 47, 3–31. Drazen, A. (2000): Political Economy in Macroeconomics, Princeton. Eucken, W. (1923): Kritische Betrachtungen zum deutschen Geldproblem, Jena. Eucken, W. (1940): Die Grundlagen der Nationalökonomie, Jena. Eucken, W. (1947): Die Grundlagen der Nationalökonomie, 5te veränderte Auflage, Godesberg. Eucken, W. (1950): The Foundations of Economics. History and Theory in the Analysis of Economic Analysis, Translated by T. W. Hutchison, London et al. Eucken, W. (1951): Unser Zeitalter der Mißerfolge, Fünf Vorträge zur Wirtschaftspolitik, Tübingen. Eucken, W. (1952a): Grundsätze der Wirtschaftspolitik, Tübingen. Eucken, W. (1952b): This Unsuccessful Age or The Pains of Economic Progress, New York. Fetter, F. W. (1965): Development of British Monetary Orthodoxy 1797–1875, Cambridge, MA. Friedman, M. (1948): A Monetary and Fiscal Framework for Economic Stability, American Economic Review 38, 245–264. Friedman, M. (1951): Commodity-Reserve Currency, Journal of Political Economy 59, 203–232, reprinted in Friedman (1953). Friedman, M. (1953): Essays in Positive Economics, Chicago. Furubotn,E.G./Richter, R. (2005): Institutions and Economic Theory. The Contribution of the New Institutional Economics, 2 nd ed. Ann Arbor. 496 Rudolf Richter Schmollers Jahrbuch 132 (2012) 4 OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.132.4.473 | Generated on 2023-01-16 13:36:42