History of Economics


11th Neoliberalism




1st Introduction: Ordoliberalism

2nd Representatives

3rd Constituting principles

4th Regulating principles

5th Instability of mixed systems

6th The principle of market conformity

7th Interdependence of orders

8th The social question with Eucken

9th The role of the state

10th Hayek's variant



1st Introduction: Ordoliberalism


In the time after the Second World War, a renaissance of liberal thought emerged, one of the main representatives of this neoliberalism was Walter Eucken and the Freiburg School.


Like the old liberalism, Walter Eucken was convinced that only the free market is capable of efficiently aligning production with the needs of consumers.


In contrast to the old liberals, however, Walter Eucken was convinced that individual freedom was not only threatened by the state, but that entrepreneurs and private interest groups also strived to circumvent the competition necessary for the functioning of the market economy by means of monopolistic mergers. It was therefore not enough for the state to establish a competitive order in a single act, but it was required to defend this order at all times by means of an active competition policy. It is precisely for these reasons that Walter Eucken advocates, among other things, a ban on cartels.


Neoliberalism calls for a strong state which, however, is limited to measures that are in line with the market. While old liberalism, with few exceptions, rejected any intervention by the state in the market economy, Walter Eucken considered it quite necessary for the state to take economic policy measures which, however, had to be in line with the market always.


For the market to be able to fulfil its tasks it requires, according to Walter Eucken, an economic order (ordo) guaranteed by economic policy. Walter Eucken named seven constituting principles which are indispensable for the functioning of a market economy.


In addition to the constituting principles that determine the establishment of a market order, economic policy always has the task of preventing on the one hand the internal erosion of the competitive order once it has been created, and on the other hand to prevent undesirable market results. The regulatory principles serve this purpose.


Within the framework of criticism of Walter Eucken's lines of thought, we must distinguish between two different directions. For one thing, criticism can be directed against the principles of this order itself. For another, criticism can also be made within the framework sketched out by Eucken, in this case the criticism refers to individual forms of the economic order. For example, B. Steinmann criticised the fact that the criterion of market conformity only referred one-sidedly to the principle of a functioning price mechanism; it was suggested that the market conformity of a measure should be evaluated on the basis of all seven constituting principles.  Or else, it was stated by Theodor Pütz that the question of whether a measure was still market conform depends on the closer circumstances and furthermore on the extent of the applied measure.


Finally, Friedrich von Hayek argued against the proposal of a ban on cartels that the power of private interest groups often had to be attributed to a flawed competition policy, that with Walter Eucken too much attention was paid to actual market conformity; it was neglected that also potential competition from abroad had an effect that maintained competition.  



2nd Representatives


Neoliberalism in the form of ordo-liberalism respectively the Freiburg School was founded primarily by Walter Eucken, Franz Böhm, Leonhard Miksch, K. Paul Hensel and Wilhelm Röpke. Occasionally, Friedrich August v. Hayek is also attributed to neoliberalism, although he clearly differs from the representatives of ordo-liberalism in several points. Somewhat different directions of neoliberalism can be found with Alfred Müller-Armack and with Alexander Rüstow.


Walter Eucken lived from 1891 to 1950, was a German economist and founder of the Freiburg School. His main works were: 'Kapitaltheoretische Untersuchungen' (1934), furthermore: 'Die Grundlagen der Nationalökonomie' (1940) as well as 'Grundsätze der Wirtschaftspolitik', published posthumously by K. Paul Hensel in 1952.


Walter Eucken tried to mediate between historical and theoretical methods in the dispute over methods. In his opinion, a general theory was necessary, but historical elements were given by the multitude of different market forms. The economic theory based its problem variables on the six economic data: Demand, labour, nature, capital, technology, order. In his morphological theory of market forms, Walter Eucken also distinguished markets according to the number of market participants on both sides of the market: In the case of monopoly, one side of the market is represented by a single market participant, in the case of oligopoly, competition takes place among a few, and only in the case of the market form of complete competition there would be a large number of market participants on both sides.


Within the framework of his regulatory policy propositions, which will be the only topics discussed in this chapter and which were summarised in the posthumously published Grundsätze der Wirtschaftspolitik (=Principles of Economic Policy), Walter Eucken distinguishes between constituting and regulating market principles. Among the constituting principles, Walter Eucken counts first and foremost the guarantee of a free price mechanism. Furthermore, he considers of decisive importance the primacy of monetary policy, private property, the principle of liability, the constancy of economic policy, freedom of contract and the guarantee of open markets. These six additional principles were the precondition for the free-market mechanism to be able to fulfil its regulatory tasks.


However, it was not enough to constitute an economic order; the state also has the task of constantly monitoring the observance of the order. For this purpose, monopoly control, an income policy guaranteeing a minimum income, the correction of external effects as well as the consideration of an anomalously developing labour supply were necessary as regulating principles.


Franz Böhm lived from 1895 to 1977 and was a co-founder of the Freiburg School. His work on 'Wirtschaftsordnung und Staatsverfassung' (Economic Order and State Constitution), Tübingen 1950, is of particular importance. His academic work was primarily focused on economic competition, which required a legal order. Competition left to its own devices would lead to its own destruction and this could only be avoided if the state decided to restrict competition.


Leonhard Miksch, who lived from 1901 to 1950, is among the order theorists of the Freiburg School and laid down his basic ideas primarily in his work on 'Wettbewerb als Aufgabe - Die Grundsätze einer Wettbewerbsordnung'(Competition as a Task - The Principles of a Competition Order), published in 1937. Regulating always meant regulating in freedom. If competition cannot arise on its own, the state should organise 'competition as if'.


K. Paul Hensel lived from 1907 to 1977. He was a student of W. Eucken and posthumously published Walter Eucken's Grundsätze der Wirtschaftspolitik ', whereby only key words existed for several parts of this work, which Hensel then formulated in such a way that a complete, coherent writing on Walter Eucken's basic ideas on regulatory policy emerged. 


Hensel himself, who published his work on 'Einführung in die Theorie der Zentralverwaltungswirtschaft' in 1954, dealt with the question of the extent to which a centrally administered economy is actually capable of solving the basic economic problems of scarcity. In contrast to his teacher, he affirms the possibility of efficient planning within the framework of a centralised economy. As is well known, Walter Eucken held the view that a centrally managed economy was not at all capable of optimally distributing economic resources among the individual types of use.


Wilhelm Röpke lived from 1899 to 1966. He was a Swiss economist and co-founder of the Freiburg School. His main works deal with the following topics: 'Crises and Cycles' (1936), furthermore: 'The Social Crisis of our Time' (1942) as well as: 'A Humane Economy: The Social Framework of the Free Market' (1958). Röpke contributed significantly to the spread of ordoliberal ideas and viewed the social market economy as a third way in between radical liberal and socialist economics.


Friedrich August v. Hayek lived from 1889 to 1992, was an Austrian economist and social philosopher and an important representative of liberalism in the post-war period. He was awarded the Nobel Prize in 1974. His most important works include 1944: 'The Road to Serfdom', 1960: 'The Constitution of Liberty' and 1968: 'Competition as a Discovery Procedure'.


In contrast to Walter Eucken, he does not speak of transaction economy, but of the market as a spontaneous order in contrast to established orders. He points out that competition should be seen first and foremost as a societal procedure that allows new techniques and products to be discovered; the actual task of the prices that are being formed in a free market is that they would be signals of scarcity.


He points out repeatedly that the global market systems were highly complex structures that did not allow economic processes to be predicted exactly in the manner of scientific laws. Economic theory must therefore limit itself to making model statements. He was also one of the very few economists who doubted the need for a state-protected banknote monopoly. Instead, he advocated privatisation and competition in the creation of banknotes.


Alfred Müller-Armack lived from 1901 to 1978 and was influenced by the ordoliberal ideas of the Freiburg School. In his book on ‘Wirtschaftslenkung und Marktwirtschaft’ (=Economic Steering and Market Economy), published in 1947, he developed the idea and the concept of the "social market economy". In his 1948 work on 'Century without God', he pointed out in a religio-sociological study the dangers of substitute religions such as National Socialism emerging in a time of apostasy. He strove for a synthesis between Neoliberalism and Christian social teaching.


As of 1952, he worked in the ministry of economics under Ludwig Erhard as head of the policy department. From 1958 to 1963 he was State Secretary for European Affairs.


Alexander Rüstow lived from 1885 to 1963. He was a German economist and sociologist and co-founder of neoliberalism. His main works include 1945: 'The Failure of Economic Liberalism' and 1950-57: 'Ortsbestimmung der Gegenwart' (="Determination of the Present's Location"). His merit consists, among other things, in the unification of universal-historical and cultural-sociological insights with the economic-political principles of neoliberalism.



3rd Constituting principles


In his ‘Grundsätzen der Wirtschaftspolitik’ - principles of economic policy, published posthumously by K. Paul Hensel, Eucken developed seven constituting and four regulating principles. The constituting principles are indispensable for the functioning of a market economy, the regulating principles are not indispensable for the functioning of the market economy but are nevertheless necessary to prevent undesirable results of the market economy process.


The actual basic principle of every market economy must be a functioning price system. Only if there is a free price mechanism that is independent of state influence, it is also guaranteed that production is aligned to the needs of the individuals in the best possible way. An optimal allocation requires that the individual prices reflect the scarcity relations, and this is only the case if a free price mechanism is allowed.


The other six constituting principles include the primacy of monetary policy, private property, the principle of liability, the constancy of economic policy, freedom of contract and the guarantee of open markets. They ultimately serve to enable a functioning price mechanism.


The first thing to do is to guarantee the 'primacy of monetary policy'. Only when the value of money is stable do price relations reflect the scarcity of resources. If there is repeated inflation, an increase in almost all prices, the distribution of resources among the individual types of use is significantly disturbed since the prices are not raised uniformly at the same time.


Inflation processes rather happen in such a way that initially certain prices (e.g. of raw materials) rise and then gradually, due to manifold substitution and complementarity relationships, the price increases spread to the entire economy, whereby these price adjustments not only occur with a delay but also assert themselves to varying degrees depending on the elasticity of supply and demand.


Especially, when inflation is not limited to a one-off event but occurs repeatedly, there is the danger that the actual price ratios deviate more or less from the scarcity ratios over a longer period of time. Therefore, significant and prolonged misallocations occur. It may be that price ratios that reflect the scarcities will return over time, but the more frequently inflation processes take place, the more lasting are the misallocations caused by them.


Private property, freedom of contract and full liability are further requirements for ensuring that, on the one hand, the economic agents have sufficient incentives to apply the respectively most efficient production methods, but that, on the other hand, there is also no possibility of restricting the freedom of the market partners and unjustifiably passing on their own costs to third parties.


Private property means that an entrepreneur who succeeds in reducing costs by means of technical innovations or in increasing welfare by improving the quality of products will receive the welfare increases caused by his activities at least partly in the form of profits. Only partly because functioning competition ensures that a part of these economic gains is passed on to the end consumers in the form of price reductions.


Freedom of contract being guaranteed, is another essential requirement for the most efficient methods of production to be applied in each case. Freedom of contract ensures that the person to whom the profits from the economic activity accrue, but who is also liable with his property for faulty decisions, is in control of the type and quantity of goods to be produced. It can be assumed that in this case the probability that the best possible methods of production will be used is much greater if the decisions lie with the person who, on the one hand, also receives the profits, but who, on the other hand, must also be liable for damages.


These considerations show that freedom of contract only ever exerts its welfare-enhancing effects if the principle of liability is valid at the same time. The justification for granting enterprises significantly higher incomes than the average citizen in the event of success lies entirely in the fact that they are also liable with their property for the damage they cause in the event of failure.


This principle of liability, which was also demanded by the older liberals, originally referred to the entire property of the liable person, perhaps except for property parts which are necessary for the maintenance of the subsistence level. In this sense, it was already a perhaps questionable softening of this principle of liability when, in the context of corporations, liability was limited to the respective ownership shares in an enterprise. This limitation may be justified by the fact that, as a rule, small shareholders with their contribution do not have the knowledge necessary to have a full overview of the risks involved; it may also be added that the total assets of the mass of shareholders are also so small that full liability with the entire assets can hardly be expected of this group of persons. However, there is actually no convincing justification for the fact that major shareholders with considerable capital, who determine the decisions of corporations, should also be liable for their contributions only.


However, completely contrary to the basic idea of the liability principle demanded by neoliberalism is a situation in which enterprises rake in profits in good times, but then, when losses are incurred due to wrong decisions and the enterprise is in danger of going bankrupt, these enterprises are to be saved from ruin with state funds, i.e. also with tax funds. Such an approach does not correspond to neo-liberal thinking at all.


Of course, it may be true that such financial support for some major banks was necessary in the past financial crisis because without this state aid, in all probability, the entire financial system would have collapsed and many citizens would have had to reckon with a total loss of their assets and, moreover, many employees would have lost their jobs.


The decisive mistake, however, was that the politicians had previously allowed a few big banks to gain such a central market-dominating position. One of the indispensable principles of a market economy according to the neoliberal view is precisely that monopoly positions must be prevented in all markets, including the banking sector. This did not happen and that is why it was possible in reality for a situation to arise in which the financial system would have collapsed without state aid. If the structure of our money markets had been characterised by competition, then it would have been perfectly possible to allow a smaller bank to file for bankruptcy due to its own wrong decisions without the entire financing system collapsing as a result.


It should be pointed out in this context that bankruptcy proceedings initially only mean that the top management that caused this disaster must be replaced or that certain unproductive parts of this enterprise may have to be closed down. Bankruptcy does not mean that in the normal case all workers employed in this enterprise must be dismissed.


After all, a stable economic order can only be maintained if economic policy adheres to a constant and consistent policy; only then will the confidence arise that is a precondition for entrepreneurs also being willing to take on the risks associated with innovation and investment. This requirement also applies to the interest rate policy of the central bank. Investments influence the cost ratios and income ratio for a large number of years; only if interest rates remain largely constant in the long term, it can be expected that enterprises will also be willing to carry out the investments necessary for growth in production.


This clearly sets neoliberalism off from certain teachings of Keynesianism. In the chapter on the Keynes' school, we saw that Keynesian policy consists of a 'go and stop' procedure. If private demand declines, the state should 'step on the gas', i.e. increase government spending and lower interest rates, and vice versa, if private demand overflows and inflation phenomena are to be feared, the state should 'brake', i.e. reduce government spending and raise interest rates. However, such a 'go and stop' deprives long-term investment of any reliable risk assessment, so that the final result is that a policy which is adopted in order to increase employment contributes in this way to a decline in private investment and consequently in employment.


As a final constituting principle, Walter Eucken calls for keeping markets open.  Only if the markets are kept open to foreign countries and if no attempt is made to ward off troublesome competition from abroad by means of import duties and other import restrictions, it is possible to effectively prevent the domestic damage caused by the monopolisation of individual branches of the economy.


Walter Eucken thus speaks out against a practice of states, which had already been introduced by the mercantilists and was then repeatedly applied until almost the 1990s. Eucken and von Hayek are in agreement on this point, although Friedrich von Hayek had accused Walter Eucken of paying too much attention to morphological structures in his theory of market forms and overlooking the fact that potential competition - made possible by free trade with foreign countries - has equally positive effects as actual domestic competition.



4th Regulating principles


In addition to the constituting principles that create an order (constitution) for the markets, economic policy always has the task, on the one hand, of preventing the internal erosion of the competitive order once it has been created and, on the other hand, of preventing undesirable market outcomes.


Walter Eucken sees the most important regulating principle in an active competition policy, which should prevent the formation of monopolies. In contrast to the old liberals, Eucken does not believe that it is enough to create competition one time. The order of competition is always endangered; it must always be expected that enterprises will try to eliminate the competition that is inconvenient for them by merging enterprises. In this context, it would not be sufficient to prevent abuse by controlling existing monopolies; rather, it would be necessary to prevent the emergence of monopolies by a fundamental prohibition of monopolistic mergers.


However, competition is essential for the success of a free market economy. It is owed to competition that enterprises are under permanent pressure to look for cost reductions and quality improvements to avoid being driven into bankruptcy by their competitors.  At the same time, however, intensive competition between the enterprises also ensures that the cost reductions achieved are passed on to the end consumers in the form of price reductions.


A monopolist does not face this constraint. Since he would not feel threatened by a competing company, he could also rest on past results. Above all, a monopolist has the possibility to cut production and thus raise prices. Instead of the market rewarding a service, the monopolist receives a profit for limiting the welfare of the population.


With this demand, Walter Eucken distinguished himself from both old-liberal and interventionist ideas. Old liberalism was convinced that it was sufficient to introduce a competition order and that a competition order, once constituted, would maintain itself. In contrast, Walter Eucken repeatedly emphasised that a competitive order had two enemies, not only - as the old liberals believed - the state, but also private enterprises, which endeavoured to secure and increase their profits by trying to eliminate competition by means of mergers and combinations.


By contrast, the old-liberal concept was seized by Friedrich von Hayek. In order to maintain the order of competition, it was not so important to control the current actual competitive conditions, since potential competition could also have the intended functions of competition. It was therefore sufficient to ensure that potential competition was always permitted and not prevented by political measures (import restrictions).


If, above all, in foreign trade, all protectionist measures to protect domestic enterprises were omitted, the domestic enterprises would not be in a position to play out their monopoly power even if they had a monopoly situation on the domestic markets in the morphological sense; for if they tried to do so and tried to raise prices by reducing the domestic supply, they would always have to reckon with competition arising from abroad, since the import of foreign goods would become profitable due to the increased domestic prices. Thus, keeping the markets open would be sufficient to prevent monopolies in the long run.


Walter Eucken differed from more interventionist scientists and politicians by attempting to prevent the formation of monopolies not by means of abuse control, but by means of a strict ban on cartels. In the view of the more interventionist-oriented academics, a general ban on cartels was undesirable because, on the one hand, a monopoly position could sometimes not be prevented at all, for example if the demand was so low that a single enterprise was sufficient to cover this demand. On the other hand, mergers are sometimes desirable, e.g. to overcome structural crises. However, experience with cartels to overcome structural crises, especially during the Weimar Republic, has shown that crises can hardly be overcome in this way.


Other scholars, such as particularly Joseph Alois Schumpeter, were even convinced that monopolistic large-scale enterprises offered a better guarantee that risky innovations would be undertaken. Schumpeter drew attention to two correlations. On the one hand, enterprises that have a monopoly in their sector are exposed to a lower risk when they plan high investments in innovations. They can assume that there is no danger of a co-competitor entering the market earlier with the same innovation and thus destroying the chances of success of the defeated entrepreneur, so that in the monopoly case many more innovations were carried out.


On the other hand, a merger of enterprises into a monopoly generally leads to a substantial enlargement of the enterprise. In this case, it can be assumed that, due to the size of this enterprise alone, numerous innovations result as a desired by-product during the production process. In growth theory, it is spoken of 'embodied technical progress' in this context.


The three further regulating principles serve to exclude market failure as far as possible. Within the framework of an income policy, all people shall be guaranteed a minimum standard of living, whereby the principle that income distribution is to be coordinated essentially by the market shall continue to apply.


In the social market economy in the FRG, a way was found to shape income distribution as close to the market as possible in the form of collective bargaining autonomy. Collective bargaining autonomy clearly assigns the determination of collective wages and other working conditions to the collective bargaining partners, whereby private organisations could be formed on the part of both employees and employers to represent the interests of both market partners.


With regard to the general demand for competition, the labour market is transformed into a bilateral monopoly. The morphology of the bilateral monopoly is characterised by the fact that the most diverse results are possible, results that would have been achieved in a market with mutual competition, results that correspond to a supply monopoly or a demand monopoly, right up to option fixations in which the stronger party can dictate prices and quantities.


However, in collective bargaining practice, the strategy of step-by-step bargaining has prevailed, which generally allows for fair outcomes for both sides and also avoids misallocations that normally occur in monopoly solutions.


In the FRG, this success is due particularly to the prudent policy of the supreme labour courts. For example, the Federal Labour Court developed some basic principles that are applied in judicial disputes over the justification of labour conflicts.


The principle of dispute parity emphasises the balance of the means of labour conflict between the two bargaining parties. Without the right of employees to strike, there would be a risk of employers having a monopoly on demand in the labour markets. However, if only employees had the right to initiate a labour conflict, there would be a danger that the unions would dominate the enterprises. Thus, employers are granted a limited right to lockout - but only in the form of a defensive lockout.


The principle of proportionality of means of action requires that the labour conflict is indispensable for the realisation of the workers' demands. Furthermore, a strike is not permitted if it unduly harms the interests of third parties or if it violates public welfare aims. A strike must also not be directed against the activity of state bodies in the exercise of their state functions.


The principle of the neutrality of the state prohibits the state from intervening unilaterally in the bargaining process in favour of a bargaining party. This principle also prohibits unemployment insurance from providing unemployment benefits to striking employees for the duration of the strike.


Finally, the principle of the peace obligation states that no labour dispute measures may be taken as long as collective bargaining has not been declared as failed. However, warning strikes (limited to a few hours) are exempt from this prohibition.


In the event that large shares of employees in a sector are not covered by collective agreements either because they are not members of a negotiating trade union or because the employer is not a member of the negotiating employers' association, it is still possible for one of the collective bargaining parties to apply to the state labour minister or the federal labour minister for the collective agreement in force to be declared universally applicable. Such a solution is much more in line with neo-liberal principles than trying to fix a statutory minimum wage for all sectors of the economy. The differences between the individual sectors of the economy are far too big for a mutually satisfactory solution to be found in a statutory minimum wage. The solution of a declaration of general applicability presupposes, of course, that the trade unions also strive to organise employees in all branches of the economy.


The regulating principles furthermore require that external effects must be internalised by state intervention in "precisely ascertainable cases". In this context, external costs are always referred to when scarce resources are used in production that can be obtained free of charge due to the lack of a property regime. Addressed in this context is particularly the environmental problem. Many industrial enterprises discharge wastewater into rivers or environmental toxins such as carbon dioxide into the air without bearing the damage caused by these activities. Here, it is necessary to look for solutions to internalise these costs, i.e. to charge the originators of this environmental damage.


At the time when Walter Eucken formulated his principles, there were only very few and not very helpful proposals in economics as to how these external effects could be internalised. Essentially, there was Pigou's proposal to impose a tax on the enterprises generating external effects in the amount of the respective external costs. The only difficulty with this proposal was that there were no markets for this environmental damage and that therefore there was no way of specifying the extent of the damage in the form of a price.


Later, the property rights movement, a group of liberal-minded economists, put forward proposals for the internalisation of external effects that brought a solution to this problem. This group correctly recognised that the real reason that externalities arise is because property rights do not exist for certain goods. Air was long considered a free good that anyone could use in any quantity. As a result of externalities, air became polluted and thus pure air became a scarce good.


According to this proposal, the state issues so-called pollution rights, which the enterprises that carry out polluting productions have to purchase. In this way, enterprises gain strong incentives to develop new, more environmentally friendly processes, because they have to purchase fewer pollution rights for the same amount of product. By allowing the state to buy back some of these rights after a certain period of time, there is also the possibility of reducing the amount of pollution. 


Walter Eucken considers certain interventions in the market to be justified even if an anomalous behaviour would have to be detected on the labour markets. As is well known, neoclassical theory describes supply behaviour as normal when there is a reduction in supply in the case of price reductions, but an expansion in the case of price increases. In developing the supply curve in the context of both the marginal utility school and Stanley Jevons' labour disutility theory, we have seen that normal labour supply can be explained from the course of decreasing marginal utility of leisure respectively from the course of increasing marginal disutility of labour. How do we now explain the possibility of an abnormal labour supply?


We want to assume that the wage rate declines and that this wage variation leads to an increase in labour supply for certain employees. Such behaviour becomes understandable if we assume that the employee under study had previously received a wage income close to the subsistence level. If the wage rate now declines, the wage income would fall below the subsistence level in the case of a reduction in supply, but also in the case of a constant supply. In this situation, without the help of the state, the employee has no other option than to work more to reach the subsistence level. There is certainly agreement that this is a situation that is unacceptable from a socio-political point of view and that even if in general the market results are considered as the better solution, state aid is indispensable in this case.


At first, it appears that the postulate of the constituting principles is softened via the regulating principles and measures are recommended or tolerated that are otherwise considered not to be in conformity with the market. It is therefore not surprising that Walter Eucken initially recommends a strict application of the constituting principles, in the expectation that the need to apply the regulating principles and to resort to means that are not in conformity with the market will then only arise in the rarest of cases.


Thus, the problem of monopoly control could be solved largely in conformity with the market by allowing free foreign trade and thus enabling potential competition, which reduces the negative effects of monopolistic markets even if monopolies arise within an economy. According to the current state of knowledge, the problem of external effects can already be solved in line with the market by the state creating pollution rights. The danger that employees, despite regular work, do not even reach the subsistence level with their wage income can also be increasingly limited with a consistent education policy.


To be continued!