Ludwig Erhard ended price controls on a Sunday and launched a miracle

The best way to lose a political argument is to be right at the wrong moment, and the best way to win one is to be right at a moment when nobody can afford to look away. In June 1948, an economics professor with a pipe, a round face and a talent for annoying the people in charge did the second thing. He did it on a weekend, because the offices were closed and the people who might have stopped him were out of town.

That is more or less the legend of Ludwig Erhard and the day he ended price controls in the western zones of occupied Germany. Like most good legends it has been polished with retelling, and I will separate what we can say with confidence from what is embroidery. But the core is true, and it is among the most instructive economic stories of the twentieth century. A people who had been told for fifteen years that a planner must decide what things are worth were handed, nearly overnight, a market, and the shops filled.

The Germany Erhard inherited

Start with the condition of the country. By 1945 Germany was in ruins, divided into four occupation zones, and its economy had been run for over a decade by a regime of central control, first under the Nazis and then, in a different form, under the occupation authorities. Prices and wages were fixed. Rationing governed food and goods. The Reichsmark, the currency, had been so inflated by wartime finance that it had little real value, and the controls were hiding that fact rather than curing it.

The results were what one would predict. Goods disappeared from the legal market. Producers withheld products they could not sell at the official price, and people turned to the black market and to barter, in which cigarettes served as money. A worker might show up to work less, because pay bought almost nothing, and spend his days foraging. Shops displayed empty shelves, and stockpiled goods sat in warehouses. This is the pattern that conservatives point to in every price-control regime, and the same story appears in a thought experiment where every price in town is set by a committee and in Rent control's record from Stockholm to San Francisco is the same story. Price controls do not abolish scarcity. They hide it and make it worse.

Who was Ludwig Erhard

Erhard was born in 1897 in Fürth, in Bavaria. He was wounded in the First World War, studied economics, and by the 1930s was working in an economic research institute in Nuremberg. During the war years he worked on plans for the postwar economy. After the war the American occupation authorities in Bavaria appointed him to a minor post, and he rose quickly. In 1948 he became director of economics for the combined American and British zone, a post in the administration known as the Bizone.

His convictions came from a school of thought sometimes called ordoliberalism, centered at the University of Freiburg around Walter Eucken. Its central idea was that a market economy needs a strong framework of rules, with the state enforcing competition and preventing monopoly, but that the state should not try to direct production or fix prices. The term social market economy was coined by another scholar, Alfred Müller-Armack, and Erhard made it his program. The market was to be the engine, and the state the referee.

June 1948: the currency and the decontrol

Two things happened in June 1948, and they are often run together. It is important to separate them.

The currency reform. On June 20, 1948, a Sunday, the Western occupation authorities introduced a new currency, the Deutsche Mark, in the three western zones. The old Reichsmark was replaced at rates that wiped out much of the paper wealth that had accumulated, while giving each person a small amount of new money to begin with. This was an Allied act, designed mainly by American advisers, and Erhard did not control it. Its purpose was to restore a sound money so that prices could mean something again.

The decontrol. Erhard's own act was to link the new currency to the end of most price controls. Just before the reform, the Economic Council of the Bizone, over which Erhard presided as director of economics, passed a law setting out guiding principles that allowed him to lift controls on a wide range of goods. On the weekend of the currency reform, Erhard announced by radio that many price controls and rationing rules were lifted. Not all: rents, some basic goods and some raw materials remained controlled for a time. But a large part of the system of fixed prices was gone.

There is a famous story that Erhard, when told by an Allied official that he had no authority to lift the controls, replied that he had not changed the rules but had simply abolished them, and that the occupation rules allowed the German administration to relax the rationing rules on its own. Another famous story has the American military governor, Lucius Clay, telling him that his advisers were horrified, and Erhard answering that his were too. I would treat those exchanges as tradition, not as verified quotation, because they have reached us through memoirs and retelling. What is solid is that Erhard acted without waiting for the occupation authorities' approval of the specific step, and that the occupation staff disapproved of the decontrol and tried to limit it.

What happened next

The reported result was dramatic. Goods that had been hoarded appeared in shop windows. Producers, who now had a currency worth holding and prices they could set, brought goods to market. Workers had a reason to show up, because wages bought something. Absenteeism fell, output rose, and the black market shrank. Within months the country felt a change that the controls had denied it for years.

I do not want to overstate it. The recovery was not instant, and unemployment rose after the reform as firms adjusted to real prices. There was real hardship, and workers protested that prices were rising faster than their wages. Erhard faced criticism in the press and in the Economic Council, and he held his position under pressure. But by the early 1950s, German output was growing quickly, and the pattern of the 1950s, which Germans themselves called the Wirtschaftswunder, the economic miracle, was set.

The social market economy and its limits

Erhard served as economics minister in Konrad Adenauer's governments from 1949 to 1963, and he turned his convictions into a program. His book Prosperity for All argued that competition was the best social policy, because it delivered the widest range of goods at the lowest prices to the largest number of people. He fought cartels, and he pushed for a law against restraints of competition. He favored open trade and a strong, stable currency.

The "social" part of the phrase was real. West Germany had a safety net, a system of insurance for illness, old age and unemployment, and a role for labor in company governance. Erhard accepted a framework of social protection, but he believed that it should work with the market, not replace it. In practice, the balance shifted over the years. In the years that followed, spending on pensions and other social insurance grew, and Erhard worried about the long-run cost and about the habit of dependency. This is the tension within the social market model, and it is the one that conservatives who admire Erhard have to face honestly: a welfare state, once set up, tends to grow, and the market economy that pays for it can be strained.

The best objections

A fair account must give the critics their due. There are at least three serious objections.

The Marshall Plan did it. Between 1948 and 1952 the United States provided billions of dollars in aid to Western Europe, and Germany received a share. Some historians argue that this aid, together with the currency reform, explains the recovery, and that Erhard's decontrol was a small part of it. There is something in that. Aid helped, and I do not claim otherwise. But the same aid went to many countries, and an aid program does not by itself explain why shops filled in Germany once prices were freed. Money alone does not produce a recovery. It needs institutions that let it be used well.

Germany was catching up. A country that falls far behind its potential will grow fast as it rebuilds, so the miracle was partly the natural rebound of a war-damaged economy with skilled workers and existing industry. That is true, and it is a reason not to claim too much. But the rebound had to be allowed to happen. The East German half of the same nation had the same skills and the same history of industry, and it did not rebound the same way. (For that comparison, see Two Germanys and two Koreas, the natural experiments that socialism lost.)

The state did a lot. West Germany was never a pure free-market economy. It had a large public sector, powerful unions and government support for housing, and its model was never laissez-faire. True, and Erhard never claimed otherwise. The point is that the central planning of prices and production was dropped. A mixed economy with a market at its center is different from a controlled economy with a market at its edge.

What it teaches about courage in policy

Here is what I take from the story.

1. Prices are information, and controls destroy it. The shops filled because the price system came back to life, as Hayek and Mises had argued it would (see The Austrian school in plain words, from Carl Menger to Friedrich Hayek). When a price is free to move, it tells producers what to make and consumers what to economize. That information is what a planner never has.

1. Sound money and free prices go together. A currency that holds its value gives prices meaning, and free prices give a currency something to measure. Erhard's decontrol worked in part because it came alongside a reform of the money. Without the new currency, free prices would have meant a burst of inflation. Without free prices, the new currency would have hidden the shortages. Each half needed the other.

1. Doing the right thing may require acting before you are permitted to. Erhard's act was a political risk. He did not wait for a consensus, because there was no consensus to wait for. He had a theory, he had the evidence of the black market in front of him and he accepted responsibility for the outcome. I would not make a rule of acting without authority, because the rule of law matters more than any one policy. But in the case of a man who has the lawful power in his office, as Erhard did as the director of economics, the lesson is that a leader who waits for a safe moment may wait forever.

1. Reform has costs, and the reformer must stay in the room. The early period was hard. Prices rose, unemployment went up and the unions struck. Erhard survived because he kept explaining, and because results arrived. Leaders who want reform need patience as much as nerve.

1. The test is the ordinary person's shopping basket. The measure of success was not a theory or a statistic. It was that a person could walk into a store and buy what he needed. A policy that works shows up in daily life.

A cautionary note about the Chancellor

Erhard succeeded Adenauer as Chancellor in October 1963 and served until the end of 1966. Here the record is less happy. His governing coalition broke apart in the autumn of 1966 over a budget gap, and he resigned on November 30, 1966. The man who had been a magnificent economics minister was an uncertain party leader. It is a useful reminder that the skills needed to design a policy and the skills needed to hold a coalition together are not the same, and that admiration for a policy should not turn into worship of a person. A conservative values institutions over heroes for exactly this reason. For other examples of leaders who pushed against conventional wisdom, see PATCO 1981, the strike that ended with 11,000 controllers fired.

The case in brief

1. By 1948 West Germany's price controls and rationing had driven goods into the black market and stalled production, as controls predictably do.
2. On June 20, 1948, a Sunday, the Western Allies introduced the Deutsche Mark, and Ludwig Erhard linked that currency reform to the lifting of most price controls on his own authority, over the disapproval of occupation staff.
3. The shops filled, output rose and the Wirtschaftswunder of the 1950s followed, though aid, catching-up and a large public sector also played a part.
4. The social market economy worked as a market with a framework of rules and a safety net, but its welfare commitments tended to grow, a tension Erhard himself worried about.
5. The lesson is that free prices and sound money go together, and that policy reform requires both courage and patience.

What you can do: the next time a politician proposes a price cap, ask them in writing what happens to supply at the capped price, and cite a historical example when you do.