From economic stability to social order: The debate about business cycle theory in the 1920s and its relevance for the development of theories of social order by Lowe, Hayek and Eucken∗

∗ Comments and suggestions by two anonymous referees are greatfully acknowledged.

Abstract

The concepts of Adolph Lowe, Friedrich A. Hayek and Walter Eucken play an important role in the discussion of an adequate theory of economic and social order. It is noteworthy that at the beginning of their academic careers, these three economists dealt primarily with questions of business cycle theory. As we will show, this is not coincidental, but can be explained by economic history and the history of theory. Furthermore, all three economists agree that establishing a comprehensive social order would provide the basis for economic stability, although each postulates a different relationship between liberty and order.

Keywords:

• Business cycle theory
• theories of social order
• liberalism
• economic policy

Notes

∗ Comments and suggestions by two anonymous referees are greatfully acknowledged.

1 The immediate cause for Lampe's remarks was an article by Gustav Cassel titled ‘Verringerung der Arbeitslosigkeit und der Notstandsarbeiten’ (Reduction of unemployment and relief work) (Cassel 1926). In it, Cassel argues that wage reduction is the only way to overcome unemployment, rejecting all social measures. A debate followed in the journal Soziale Praxis (Social Practice), and this is where Lampe's essay was published. In addition, Lampe dealt with the subject in a monograph (Lampe 1927a). The debate is documented in Janssen (2000: 394 – 404).

2 Of course, some representatives of the Historical School argued in favour of the under-consumption theory too (cf. Janssen 2000: 335).

3 As far as empirical research is concerned, reference should also be made to the Deutsches Institut für Konjunkturforschung (German Institute for Business Cycle Research), founded in 1925 in Berlin by Ernst Wagemann. From 1924 to 1926, Lowe, as the head of the international department of the Statistisches Reichsamt (Statistical Office of the German Reich) was a close colleague of Wagemann. For more information on the beginnings of empirical business cycle research in Germany, especially with respect to Lowe and the Kiel Institute, see Kulla (1996) or Beckmann (2000).

4 For instance, Berlin researchers used the Harvard barometer.

5 Accordingly, one cannot but agree with Pribram when he writes that ‘the changes in economic reasoning which took place in the Western countries affected the general approach to economic policy problems rather than the fundamental aspects of the predominant hypothetical doctrines’ (Pribram 1983: 415). This might also explain Schumpeter's somewhat delphic verdict – in light of the boom of business cycle theories in the 1920s – in his ‘History’, ‘that all the fundamental ideas concerning the phenomenon of business cycles were present before 1914’ (Schumpeter 1954: 1164).

6 The interwar period, then, might possibly be considered the time when a view came into being in Germany which was later exposed as a fallacy by Gunnar Myrdal: ‘We must try to lay bare the specific logical errors resulting from the insertion of valuations. These insertions are due to the logical impossibility of deriving positive political conclusions from mere premises facts’ (Myrdal 1965: 18).

7 This is true for four further economists: Eugen Altschul, Oskar Morgenstern, Wilhelm Röpke and Kurt Singer. Altschul, Morgenstern and Singer, however, were considered business cycle researchers rather than business cycle theoreticians. In contrast, Röpke can be viewed as further evidence for the aforementioned claim: starting off as a business cycle theoretician (first following Spiethoff, then working on monetary business cycle theory), Röpke later developed social policy concepts (cf. Civitas humana, 1944 and Jenseits von Angebot und Nachfrage, 1958[A humane economy: the social framework of the free market], 1998 [1960]) that fall within the research programme of the Freiburg School of Law and Economics in a broad sense. A further argument emphasizes the importance of Lowe, Hayek and Eucken as business cycle theoreticians of their time: all three of them can be found in a monograph edited by Howard S. Ellis in 1934 (German Monetary Theory 1905 – 1933, Part 4: ‘Business cycles’). A selection similar to the one used here can also be found in the convincing essay ‘Der Beitrag deutschsprachiger Ökonomen zur konjunkturtheoretischen Debatte der Zwischenkriegszeit’ (The contribution of German-speaking economists to the business cycle theory debate of the interwar period) by Christof Rühl (1997). Rühl bases his analysis on Hayek, Lowe, Friedrich A. Lutz and Schumpeter. Lutz, a student of Eucken's and author of the important analysis Das Konjunkturproblem in der Nationalökonomie (The problem of business cycles in economics) (1932), however, is not nearly as interesting as Eucken when it comes to questions of economic and social order. Schumpeter, on the other hand, had already developed the essentials of his theory prior to World War I and is thus not really representative of the interwar period. Furthermore, one should mention Alexander Rüstow in this context. Even though his main research interest was not the business cycle theory, he had a profound impact on the development of economic theory in the 1920s and 1930s. First, being a member of the ‘Kairos-circle’, a circle of ‘religious socialists’ to which – among others – Paul Tillich, Adolph Lowe and Eduard Heimann belonged, he later became a supporter of ordoliberal ideas. Crucial for his ‘conversion’ toward a more ordoliberal perspective was his presentation at the meeting of the Verein für Sozialpolitik in 1932. There Rüstow (1932) presented – independently from Eucken – his idea of a ‘strong state’, strong enough to repel privilege-seeking interests groups, which became central for the Freiburg School's research agenda. Rüstow became a close friend of Lowe and also of Eucken. Although Rüstow and Lowe later developed different theoretical and political approaches (even though both shared the idea of a necessarily social dimension in economics) – Rüstow's friendship with Lowe was lifelong.

8 However, it is easy to see that Lowe himself falls prey to thinking in full employment equilibria: he assumes that ‘changes on the monetary side alone cannot cause the cycle’ because ‘the effective amount of purchasing power is not changed by them at all’ (Löwe 1997 [1926]: 258). But this is not necessarily the case when the adjustment process is viewed dynamically (cf. Kromphardt 1996: 264).

9 The focus on structural and technological change is, as is well known, a leitmotiv in Lowe's work and culminates in a traverse analysis, as developed by Lowe in The Path of Economic Growth (1976; cf. Hagemann and Landesmann 1998: 95f and 125). At the same time, the citation also illustrates the central contentious issue between Lowe and Hayek about the decisive endogenous factor: money and credit vs. technological change (cf. Hagemann 1994).

10 In his 1926 essay, Lowe propagates a theory of cyclical economic development which is based on Rosa Luxemburg's theory of imperialism (cf. Rühl 1997: 266). There is, of course, not a particularly long way to go from there to state interventionism: ‘Growth needs to be directed and fluctuations need to be controlled and limited’ (Nell 1998: 131).

11 His idea of three phases in the development of capitalism is reminiscent of the tradition of economic stages within the German Historical School (cf. Schefold 1998: 238). In consequence, Lowe describes economic ‘laws’ as historically relative: ‘Obviously these popular disputes cannot be settled by professing a general principle, such as free trade or autarchy, neutrality of money or any alternate dogma. We must be told what the structure of a system as a whole looks like, how the data are co-ordinated in the concrete phase of the economic process in question, before we can state whether the introduction of new machinery effects long lasting unemployment, whether a fall in prices endangers the stability of the market generally, whether new savings will stimulate investment or wages cuts will induce employment. It is even of no practical use to start theoretical analysis from the assumption of general equilibrium if, in a system such as Modern Industrialism, every single economic phenomenon is subject to the rhythm of the trade cycle’ (Löwe 1936: 36). Because of the qualitative character of economic growth, changes in the very ‘data’ of the system itself will result (cf. Forstater 2003).

12 These internal rules are learned during the individual's process of socialization. Consequently, these rules are not universal and timeless, but refer to ‘the ‘incompleteness’ of human history, and point to the significance of cultural evolution’ (Löwe 1940: 3, cf. Forstater 2000: 231). Here, one can draw a parallel to modern approaches of evolutionary anthropology (see Goldschmidt and Remmele 2005).

13 As regards the role of money as an influence that is induced from outside into the stable equilibrium of a barter economy, Hayek might have been decisively influenced by his analysis of US monetary policy during his 1923/4 stay in the United States (cf. Dostaler 1994: 150). Hicks (1973: 133f) criticizes Hayek's praise of the ‘state of barter’ as a ‘delusion’: ‘It is not true that by getting rid of money, one is automatically in “equilibrium”.’

14 Terence Hutchinson's claim, thus, that Hayek II can be explained by Karl Popper's influence (cf. Hutchinson 1981) is flawed, because if one wants to explain Hayek by ‘conversion experiences’ (Böhm 1994: 107), Hayek's experience of that kind was clearly the theoretical inspiration of his teacher Ludwig von Mises (for an in-depth analysis see Caldwell 2004). Mises, on the one hand, prepared the way for Hayek's theory of business cycles in his 1912 book Theorie des Geldes und der Umlaufmittel (The theory of money and credit) (in which Mises, among other things, attacks the theory of the veil of money long before Keynes did, a fact hardly recognized nowadays). On the other hand, Mises exerted a good deal of influence on young Hayek (who still adhered to socialist ideas at that time; cf. Hayek 1992: 136) in his 1922 book Gemeinwirtschaft (Socialism) (cf. Dostaler 1994: 149), meaning that Hayek had already encountered an interface between theories of social order and theories of business cycles. For a comprehensive overview on Mises' business cycle theory and its impact on Hayek see the recent publication of Pallas (2005).

15 As Besomi (2002) points out, this is the main difference from Harrod's explanation of trade cycles. Instead of the fundamental tendency towards equilibrium and the assumption of stability in the real sector as Hayek describes it, Harrod assumes the persistence of disequilibrium. The crucial importance of relative prices in Hayek's explanation underlines once again the microeconomic approach of the Austrians in their sharp distinction to any macroeconomic assertions on cycles like in Harrod's conclusions – an approach that seems to be ignored by Besomi.

16 With this argument, however, Hayek was subject to Lowe's criticism that there is no purely monetary theory of the business cycle (cf. Lowe 2002 [1928]: 205). Consequently, Hayek rejects Lowe's interpretation of Mises' monetary theory in order to defend his own explanation (cf. esp. Hayek 1966 [1933]: 143ff). It is noteworthy that in 1929, Hayek only rarely and indirectly refers to technological process as a reason for a changing natural interest rate (e.g. a fall in unit costs; ibid.: 72); he emphasizes the importance of ‘violent fluctuations in savings’ which consequently result in ‘temporary changes in the equilibrium rate of interest’ (ibid.: 205). Whether this is really an endogenous or rather an exogenous explanation cannot be discussed here. However, it should be stated that the strong emphasis on improvement in profit perspectives due to technical advances (which causes an increase in the natural rate of interest and investment demand) is predominant especially in Monetary Theory and the Trade Cycle (1966 [1933]: 147f and 191f) – supporting Wicksell's and Lowe's line of argumentation – while in Prices and Production this impulse as a cause for a divergence between money and the natural rate of interest is eliminated (cf. Hagemann 2001: 332).

17 Once more, the comparison to Lowe should be remembered: Lowe, whose approach excludes the role of money (cf. Hagemann 1994: 115), in his later works postulates an instability of the growth path, a view which was based on his business cycle theory considerations. He argues that this holds because the pricing mechanism may not send the right signals, which presents specific tasks for economic policy makers (cf. Nell 1998: 132f).

18 Further evidence for this claim is that in his business cycle theoretical writings (as well as later in his social philosophy writings), Hayek already sought a microeconomic explanation of macroeconomic events, as Chochran and Glahe have pointed out: ‘The phenomena of trade cycle should be explainable in terms of the responses of individuals in the system to price signals’ (Cochran and Glahe 1999: 74).

19 There is, therefore, no such thing as inconsistency in Hayek's definition of prices (cf. e.g. Rosner 1994); rather, his later theories of social and economic order are only understandable on the basis of the information problem. By using ‘competition as a discovery procedure’, a tendency towards an equilibrium is generated, as Hayek impressively states in 1937: ‘It can hardly mean anything but that under certain conditions the knowledge and intentions of the different members of society are supposed to come more and more into agreement’ (Hayek 1937: 44). Thus, Klausinger's (1991: 89) question of ‘to what equilibrium the market process, as a tendency, is heading’ can be answered by stressing that what is in Hayek's interest is a ‘functioning societal system in its entirety’.

20 Owing to space limitations, we cannot deal with this problem in any detail here; cf. e.g. Vanberg (1994).

21 Contrary to Lowe and Hayek, a systematic reconstruction of Eucken's theory of social order with regard to his earlier work on business cycles is missing in the literature. Also, no in-depth discussion of his business cycle theory is available. The best source is Folz (1970: 122 – 44).

22 The mechanism of transfer does not, however, correspond to the typical Austrian pattern, where indirect production is of central importance.

23 Citations marked as ‘in Boese 1929’ refer to ‘Aussprache zu den Referaten’ (Boese 1929: 317 – 92).

24 We cannot analyse the scientific as well as (amicable) personal relations between Eucken and Hayek here in any depth. Despite obvious parallels in dealing with the problem of a sufficient order for a modern society and Hayek's high esteem of Eucken as person and scientist (e.g. Hayek invited Eucken to join the founding session of the Mont Pelèrin Society; Hayek was later a co-editor of the yearbook ORDO – which was founded by Eucken and Franz Böhm – and a long-time president of the Walter Eucken Institute), there are marked differences in their approaches (cf. e.g. Streit and Wohlgemuth 2000).

25 Interestingly, in the discussion of Eucken's paper, Carl Landauer points out the constitutional relevance of error for the problem of business cycles, a relevance which Lowe and Hayek – as has been mentioned above – deny. Landauer said: ‘If there were no errors, if we knew for sure how business cycles are developing, then there would, of course, be no business cycles. I want to explicitly set forth here that business cycle theory as well ought to consider the relevance of errors.’ (in Boese 1929: 368).

26 Eucken's father, the philosopher and 1908 Nobel laureate Rudolf Eucken, no doubt exerted decisive influence on the way Walter Eucken thought about this problem. In his Prolegomena, Rudolf Eucken wrote: ‘There are two problems with which we all have to deal: One is to gain some sort of stable mental orientation and an aim for which we want to live. The other is to manage economic problems and interdependencies, which threaten the inner cohesion of mankind and which turn virtue into a struggle of man against man’ (Eucken, R. 1922: 137). For the relevance of Rudolf Eucken for Walter Eucken's work, see Goldschmidt (2002: ch. 4.1).

27 In Grundlagen (Foundations), Eucken sums up: ‘There is no such thing as “standard cycles” in business cycles’ (Eucken 1950 [1940]: 182).

28 While it is certainly true that Lutz and Eucken held similar views in the 1930s, we cannot state with certainty whether ‘Eucken […] adopted Lutz' view’ (Kromphardt 1996: 272) or whether they had simply developed their view jointly. At any rate, Eucken's and Lutz's co-operation with regard to business cycle theory has been highly relevant for the genesis of the Freiburg School of Law and Economics. For instance, the idea of Datenkranz (‘set of data’), which can be considered the ‘differentia specifica’ of ordoliberalism, was also developed in these years; cf. Blümle and Goldschmidt (2000: 24 – 8). For a comprehensive survey on Lutz' theory, refer to Hagemann (2002b: xvii – xix) and Veit-Bachmann (2003).

29 Again, Eucken explicitly rejects Keynes' theory, which, ‘among other things, was meant to explain how and why businessmen, and not consumers, stand in the centre of the modern economic process’ (Eucken 1950 [1940]: 193).

30 For a broader discussion see Vanberg (1998) and Grossekettler (1989).

31 An English translation of Eucken's constituting and regulating principles are provided in Eucken (1982).