The Greatest Economic Experiment Ever

Imagine how any political economist would salivate at the prospect of conducting the following experiment: take a homogeneous population, ideally in a fairly destitute state so that they start from scratch, separate it into two groups, keep the separation tight enough to avoid cross-contamination, subject one group to a given economic system and the other to the competing system, wait forty years, and see what happens.

Improbably enough, the experiment did take place. Germany's partition after World War II provided the ideal setting, with each of the two sectors going fairly full blast for free-market capitalism the one, and for a centrally planned economy the other. The only thing missing were the salivating economists on either side: there were grimmer things to worry about at the time.

So, how did they fare?

Both subject populations started out with huge handicaps. They had been devastated by the war, a good chunk of the industry that had survived was being dismantled by the victors, they had to pay war reparations, had lost many young men in combat, had to accommodate large numbers of refugees, and their best engineers and scientists were being siphoned away.

Our putative researchers rooting for the East German side of the experiment would have fretted in addition at the lesser availability of resources for their own test subjects, the higher level of war reparations, the deeper dismantling of industrial infrastructure and the emigration of large numbers of qualified subjects and entrepreneurs that preferred not to take part in that section of the experiment. (The emigration problem was solved eventually by the erection of an extremely impassable inter-experiment border and an infamous Wall separating the subjects' former capital city. This latter addition to the experiment not only provided a unique setting for spy films, but effectively packed two worlds in one single city.)

In view of the higher handicap for the eastern portion, the economists cheering for the western side of the experiment may have thought that their side could afford a bit more dismantling. A US directive instructed the US forces of occupation to "take no steps […] toward the economic rehabilitation of Germany." The Allies confiscated a great deal of intellectual property and all German patents. Unsurprisingly, during the two years that this practice was in place it made no sense to conduct industrial research in the country. Furthermore, West Germany was stuck with the Reichsmark for a few years, while inflation ran rampant.

So, the western subjects struggled quite a bit at the beginning, although they were benefiting from all the skilled subjects and entrepreneurs absconding from the other side to join theirs. In contrast, the dismal scientists rooting for the centrally planned economy side were already finding reasons to applaud. Their economic system, modelled on that of the Soviet Union, was doing quite well. In fact, better than the West German one at that stage.

Somewhat alarmed, and in view of the fact that the sluggishness of their subjects was becoming a drag on the economic recovery of the rest of western Europe, the overseers of the western experiment decided to allow a currency reform in 1948, which saw the Deutsche Mark become legal tender, and instituted the Marshall Plan, which injected some resources into the struggling economies—i.e. not only on their pet one, but still. Things went up from there.

Meanwhile, from one five-year plan to the next, the eastern part clocked growth rates of 3% on average in the 1960s and 1970s. It even had to import workers from places like Vietnam, Cuba, Poland, Angola, and Mozambique. It achieved a per capita GNP equivalent to 18,934 DM in 1980, eventually becoming the richest economy of all the Soviet Bloc. Reason to be smug?

Well, yes, provided you didn't look across the Iron Curtain too closely. By then their western brethren had pulled off a true Wirtschaftswunder, the West German economic miracle. Their per capita GNP was 24,107 DM in 1980, more than 30% higher than across the fence.

"The Marshall Plan", grumbled the overseers of the eastern experiment. "The inflow of German deportees and industrialists from the east," added others.

All true. However, contrary to common belief, the financial help provided by the Marshall Plan was not what drove the miracle: altogether, between debt forgiveness and outright loans, the Plan amounted to a credit equal to 5.2% of Germany's GDP for 1952. (Greece, in comparison, has so far received financial help to the tune of 161% of its GDP to overcome the euro crisis.) The Marshall Plan help for Germany was less than what the United Kingdom received, and less than Germany had to pay in reparations. So it was a welcome piece of support, but rather on the moral side than anything else.

The tale of this experiment has been told better and in great detail in a good many works. But the essence is clear: a good dose of catch-up effect, an opening up to competition, giving creativity and innovation a free hand, a solid legal framework, respect for the rules, and the economy will bloom. It will bring far more inequality, true, but far more well-being as well. Just think of South and North Korea, Taiwan and China (before the latter turned capitalist), or Chile and Venezuela, to name but a few.

As Nobel laureate Edmund Phelps put it recently, "the non-capitalist economies tend not to be high-performance economies. They can — under favourable market conditions — grow very fast and have a high level of activity (and job satisfaction too) while doing it; but then, of course, they slow down as they 'grow out of' those initial conditions. In the end they generally fail to pull up to the levels of either productivity or prosperity that the well-functioning capitalist economy tends to reach, thanks to its system for well-directed innovation and its culture of enterprise. They lack the dynamism needed to sustain the catch-up, the high job satisfaction and thus the high employment."

And now, as we celebrate the first quarter-century since the great experiment ended, we are astounded at how long-lasting the effects of the imposition of a centrally planned model upon the citizenry can be. Despite the many billions injected from the west to the east over the years, there is still a noticeable gap in productivity, earnings and unemployment levels between both sectors.

Strange, then, that the centrally planned economic model still counts so many adherents. Germany has just acquired its first state premier of that stripe in the (formerly eastern) state of Thuringia. Go figure.