Play With Competitive Forces at Your Peril

Germany following the Second World War was an economic disaster. It fell to the new finance minister Ludwig Erhard to fix it. The main problem the country faced was business cartelization. Before and during the war, the Nazi-controlled government had monopolized the domestic economy and protected producers from foreign competition, driving the country ever further into the ground. This was even before the war; the Nazis were dedicated partisans of national economic planning.

After the war, this would never do for an economic revival. The number one priority was restoring business competition. It fell to Erhard to lead the way. As he made clear in his 1958 book Prosperity Through Competition, the main enemies of the free market were the cartelized industries themselves.

“The State must not decide who should be victorious in the market,” he wrote, “nor should an industrial organization such as a cartel; it must be the consumer alone. Quality and price determine the form and direction of production, and it is only on the basis of these criteria that the selection is made. In this sense, freedom is the right of every citizen, and it must not be short-circuited by anyone.”

“My efforts are thus aimed at establishing competition firmly as the driving force,” Erhard continued, “and free prices as the regulator, of the market economy within a legal framework. Whoever wishes to go beyond these principles, or disregards them, undermines the market economy and destroys the foundation on which our social and economic order rests.”

This book was a passionate plea to restore competition, from the first page to the last. The audience was not politicians. It was not consumers. It was not state bureaucrats. The audience was the business community itself, which was the sector that needed convincing. They needed to face the cold waters of global competition if Germany was ever to regain prosperity.

What Is Competition?

Let’s unpack this economic idea of competition a bit, only because the term can be misleading. We think of team sports or a foot race. That’s not the whole of the economic idea of competition. Competition is not a game to be managed; it is a spontaneous process of entrepreneurial innovation.

It’s true that producers are set against each other in the provision of goods and services but what are they seeking? What are they competing for? Their sights are set on the interest of the consuming public: better products, better prices, better realization of people’s dreams. Each producer is incentivized to become ever more excellent in the service of others. The test of profitability is there to serve as a sign and seal of a job well done.

When a single producer comes to dominate an industry, and starts to flop at the main job of serving others, the legal system must allow free entry into the sector for other producers with other ideas for achieving the goal.

If there are legal barriers to entry, there is a problem. One producer gains a privilege and that privilege will be exploited at the expense of the consuming public. If there is free entry, a whole series of institutions spring up that serve as signaling systems. Prices reflect bids within the reality of resource availability and consumer demand. These prices are then deployed in balance sheets to calculate profits and losses.

This idea of genuine market competition – no privileges, no dictates, no limitations, no protections – consumed the postwar generation of economists for a reason. The war had cartelized not only Germany but the economies of the United States and the United Kingdom. Russia had long ago gone full socialist but a new model of noncompetitive fascist forms had become dominant in the non-socialist world. The most urgent priority was restoring competition. As Erhard says, if you don’t have that, there is no hope for prosperity.

Free Trade Means Competition

A huge problem that Erhard had inherited from the Hitlerized economy was protectionism itself. The government had instituted a policy of national self-sufficiency. Political propaganda throughout the 1930s had blasted foreign nations as unfair partners, while foreign banking interests were said to be Jewish-controlled. Foreigners were portrayed as pillagers and free trade as contrary to the national interest. Hitler’s ambition was to create an autarkic economy that permitted his superior plans to supersede international competition.

This is why Erhard made the restoration of free trade a top priority. Above all, this meant getting rid of tariff walls. There was no point in elaborate negotiations for “good deals” or demanding that other countries comply with Germany’s wishes that they too reduce tariffs or subsidies. The point was to make sure that Germany’s business sector was competitive on a global front.

“The demand to remove all obstacles to trade must naturally also be expressed in tariff policy,” he wrote. “On this point I have always stood for the principle—as in discussions about liberalization— that what is right in principle does not need to wait for an equivalent contribution from a trade partner to be realized. So, since 1955, when the domestic position of the Federal Republic made it appear sensible to reinforce competition, I have aimed to bring competition into Germany from beyond the frontiers by lowering tariffs. An autonomous reduction in tariffs was carried out in several stages, even though, according to my taste, more could and should have been done than the Government and Parliament allowed.”

By autonomous, he could have substituted the word that was later more common: unilateral reductions in tariffs. The point is that tariffs are a tax on domestic consumers. But here’s the key: if the tariff pertains to raw materials or goods purchased by business, it is also a tax on producers. A tariff operates as a coercive transfer of wealth from private hands to government officials. It’s a form of welfare that dramatically distorts the signaling mechanisms of a free market.

There is absolutely nothing a nation can gain by this. If the tariff applies to final goods, a domestic industry can be temporarily protected against foreign competition but to what end? This is a subsidy to inefficiency and bad business practices. It works for a while but it is not sustainable. At some point, the future must arrive and, unless you are willing to drive the economy backwards in time into ever more impoverishment, enterprises will have to adapt regardless.

Excuse for Power

Another problem with a tariff policy that is designed to force foreign countries into new policies is that this claim is easily abused. It becomes an excuse for an industrial policy of all-round planning. Yes, there is some populist appeal to this kind of policy, because many people are always ready to believe that bad foreign peoples are doing bad things to heroic citizens. In the end, this is just excuse making that usually ends in feeding the power ambitions of an industrial dictator. For this reason, protectionism and socialism/fascism have usually gone together.

A good example of what Erhard decided to disregard was national trade accounting between nations. He didn’t deny that data on trade deficits were interesting. But he said that such data “all too easily becomes not just a piece of knowledge but the basis of calculation for a fixed economic plan.”

Erhard ends his book with a firm condemnation of Dirigisme, which means a state-directed economy that leaves most capital in private hands. Politics decides who wins and loses, what is produced and where and in what quantity. This is not a path to prosperity. The state cannot control production, must less manage the business sector directly. Complete de-Nazification, he argued, requires a new and principled commitment away from cartels and monopolization and toward real competition and trade with no barriers. This is indeed what produced the German Economic Miracle.

This history is not so ancient, as it turns out. The demand for national self-sufficiency, and the use of tariffs as a tool of political control, is with us still. If things keep going the direction they are going in the United States, away from competition and toward Dirigisme, we too are going to need a miracle to dig ourselves out.

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