German “Ordnungstheorie” from the Perspective of the New Institutional Economics

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 representatives of 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’s Foundations of Economics is so tedious to read for modern economists. Another reason is that Eucken belonged to at that time dominant group of German “verbal” economists, who were either hostile or strongly reserved to the application of mathematical methods in economics (in those days largely differential calculus) because mathematics would belong to the natural sciences while economics is an arts discipline (see Stackelberg 1948, p. 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 proper, and no Pareto optimality, i.e., Eucken keeps clear of value theory, the prevailing economic theory of his time.³ Instead, he suggests using a mix of historic and theoretical analysis that he calls morphological approach (Eucken 1940, 1950, p. 293), but in the subsequent German literature the term Ordnungstheorie established itself. This method describes an economy, so to speak, from its outside, viz., from its general type of economic system or “order” (like “centralized economy” or “exchange economy”), as well as from general 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 Keynesian 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.”⁴ Economics 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, p. 293). How actors proceed in detail depends on “spiritual and intellectual characteristics of individual men in different periods, classes or nations” (loc. cit. p. 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 Pareto-optimality to assess economic systems or “orders.” Instead, Eucken applies the concept of economic power,⁵ which became an object of dispute between adherents of the Marginal Utility School (“pure economic theory”) and the Historical School in the early 1900s.⁶ Its 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, p. 38)

Eucken continues that economic power would reach its maximum concentration in the totally centralised economy ⁷ and its minimum in an exchange economy, ⁸ to wit, under conditions of perfect competition on all markets.⁹ But 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—and that is important—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, p. 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 chapter.

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, p. 245). That would be the “stricter” (strengere) form of science (Schmoller 1894, p. 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.)

The economic process goes on always and everywhere within the framework of a historically given economic system (or order) (Eucken 1950, p. 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, p. 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, p. 107) ¹³

Such ideal types “are … to be used as ‘models’ on the basis of which theoretical propositions can be worked out” (1950, p. 233).

Note that Eucken’s ideal types differ from Weber’s who, according to Eucken, 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. p. 173) Thus, “…the knowledge of the different kinds of systems (of Wirtschaftsordnungen) is the first step towards knowledge of economic reality.” (Eucken 1950, p. 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, p. 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 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

Of particular interest for the neoinstitutionalist are Eucken’s comments on the “datum” of legal and social organization. It is here where Eucken’s Ordnungstheorie 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. p. 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., 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, p. 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

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

We continue with a description and discussion of the basic norms or “constituent principles” that, according to Eucken, should characterize the economic constitution of an exchange economy. His constituent principles lean on the main features of the classical liberal state. They are listed in his posthumously published Grundsätze der Wirtschaftspolitik (‘Principles of Economic Policy’), and read briefly as follows (own translation):

Eucken (1952a, p. 289) emphasizes the interdependence of his constitutional principles. Only together, they are able to serve their common purpose, viz., to control the economic process through competitive pricing. Thus, if all constitutional principles would be realized but one, say “private property” or “open markets”, the control function of the price mechanism (with its power reducing effects) would no more work.

Eucken concedes that his constitutional principles require balanced interventions by Ordnungspolitik. To this end he suggests a set of regulating principles of his Ordnungspolitik regarding the passage of antitrust laws, of income redistributing tax laws, of laws to curb or avoid external costs (1952a, 292 ff.).

Opposed to neoclassical economics or macroeconomics, whose object of research is the process (the functioning) of economic activities within a given, loosely described institutional framework, Eucken’s object of research is the institutional framework or “order” itself, within which the economic process proceeds. While neoclassical microeconomists or Keynesian resp. neoclassical macroeconomists model economies functionally, as systems of structural equations (target functions and its constraints such as production functions, utility functions etc.) or behavioral equations (consumptions functions, investment functions, etc.³²) suggests Eucken to model economies “morphologically” by assigning observed institutional structures to their respective ideal types (1950, p. 223).³³ Insofar Eucken assumes an institutional economic point of view. We ask: what can be said about Eucken’s approach from aspects of NIE? To answer this question, we’ll discuss in the following his above listed constitutional principles.