Isabella M. Weber

How to Make a Miracle? Ludwig Erhard’s Post-War Price Liberalisation in ’s 1980s Reform Debate

March 2019 Working Paper 03/2019 Department of Economics The New School for Social Research

The views expressed herein are those of the author(s) and do not necessarily reflect the views of the New School for Social Research. © 2019 by Isabella M. Weber. All rights reserved. Short sections of text may be quoted without explicit permission provided that full credit is given to the source. How to Make a Miracle? Ludwig Erhard’s Post-War Price Liberalisation in China’s 1980s Reform Debate1 Isabella M. Weber, Goldsmiths, University of

Abstract

This paper develops a comparative and connected history of the debates over transition to a market economy in West- after World War II and in China during the first decade of reform and opening up under Deng Xiaoping (1978-1988). At both historical moments the political aim was to reintroduce market mechanisms into a dysfunctional command economy. The question what kind of price reform this required was subject to heated debates among economists. This paper shows how the West-German 1948 currency and price reform was introduced into the Chinese reform debate by German ordoliberals and neoliberals like Friedman. It traces how the West-German case study was mystified as “Erhard Miracle” and became a metaphor for the shock therapy of universal overnight price liberalisation in China.

Keywords: Ordoliberalism, Price reform, Socialism, China, Market transition, Ludwig Erhard.

1. Introduction

Key national economic institutions in our present global economy were shaped at two critical crossroads of the 20th century. The first was the transition from the Second World War when different visions for a peace economy competed (e.g. Galbraith, 1980; Hayek, 1944). The second was the divergence between Russia’s fall and China’s rise at the end of the short 20th century (Nolan, 1995). At both moments in history new economic orders were created by reviving market mechanisms. At both times the starting point was wide-ranging economic controls. Twice a fierce debate arose around the question whether the market would require universally free prices or whether instead price controls would continue to be relevant for a gradual creation of contained market mechanisms. Neo- and ordoliberal visions of a free market encapsulated in the free movement of prices to be achieved by rapid liberalisation at all costs competed with more pragmatic liberal and socialist outlooks that saw a positive role for price regulation and proposed a gradual kind of transition (Collander, 1984; Laguerodie & Vergara, 2008).

Different visions of transitioning to a peace economy became dominant after World War II in different countries. In particular, Great Britain and West-Germany came to represent two

1 I would like to thank all my interview partners, Peter Nolan, Lin Chun, Harald Hagemann, Fan Shitao, Wang Xiaoqiang, Wei Zhong, Felix Wemheuer, Adrian Wood, Wu Jinglian, the participants of the 50th annual UK History of Economic Thought Conference at Balliol College Oxford and of a workshop at the Federal Foundation for the Study of Communist Dictatorship in East Germany in November 2018 for instructive comments on draft versions of this work. All remaining shortcomings are my own.

1 alternative paths: gradual liberalisation under an interventionist state (Cairncross, 1985a) and ordoliberal over-night liberalisation to create a social market economy (Abelshauser, 2004, pp. 86- 106). The West-German post-war economic boom gave rise to the mystification of the policies of the Western allied forces and Ludwig Erhard as “Erhard Miracle”. This was later invoked in the debates over how to transition from some form of a mixed or planned economy to argue for radical price reform (e.g. Friedman, 1977).

This paper establishes, that when China after the sought to create a new economic order, the West-German post-World War II experience was of great interest to the political leadership and reform intellectuals. Against this background, I enquire what role the so- called Erhard Miracle played in China’s price reform debate in the critical first decade of economic system reform (1978-1988). I show how the West-German post-war reforms became stylized as the deed of one man, Erhard, and mystified as a simple policy that created immediate success. As such the Erhard Miracle (艾哈德奇迹) became a powerful metaphor for a radical form of price liberalisation, akin to what came to be known as “big bang” later implemented in Russia (e.g. Åslund, 1992; Kornai, 1990; Lipton & Sachs, 1990). This paper traces the contributions by prominent German ordoliberals like Wolfram Engels and Armin Gutowksi as well as Milton Friedman during their travels to China and analyses how the metaphor of the Erhard Miracle was subsequently used by prominent Chinese free market reformers like Wu Jinglian.

The paper aims to make a contribution to the growing literature in global intellectual history that studies how ideas travel (Moyn & Satori, 2013). The Chinese history of economic thought, especially for the contemporary period, yet remains largely to be written (Chang, 1987; Hu, 2009, p. i; Peach, Lin, & Fang, 2014, p. 52). In particular, the watershed decade of the 1980s that saw a burgeoning exchange with a wide range of foreign economists and that marked the revival of economics as an academic discipline in China merits attention. 2 Rather than conceptualising China’s reform debates as isolated and foregrounding its “Chinese characteristics”, this paper seeks to demonstrate how the fierce struggle in China over how to carve out a path for economic reform has been deeply connected with international debates over the creation of a market order. It also explores how a concrete instance in economic history becomes stylized into a metaphor for a certain theoretical outlook and travels to a different national context. As such I tell a comparative

2 The edited volume The History of Ancient Chinese Economic Thought (C. Lin, Peach, & Wang, 2014) is a pioneering contribution to the field. Contributions in English language that treat the more contemporary history of economics and economic thought in China include: (Fewsmith, 1990, 1994; Gewirtz, 2017; Lin, 1981; Wang Xiaoqiang, 1998; Weber, 2018; Weber & Semieniuk, 2019). The Routledge series Chinese Economists on Economic Reform provides the most comprehensive collection of translations by renown Chinese economists (e.g. Deng, 2017; Du, 2018; Guo, 2012; Lou, 2014; Ma, 2014; Yu, 2014). (

2 and connected history of the West-German post-World War II experience and the Chinese market reforms. This is a first step towards a new historiography of the intellectual foundations of the transition from a centrally planned economy: the question of plan and market under state socialism is reconnected with the debates over the post-war order and indirectly the socialist calculation debate.

The first section provides an overview of the intellectual origins and actual course of the 1948 West-German currency and price reform drawing mainly on German language scholarship. The second section first explores how ordoliberal and neoliberal economists introduced the Erhard Miracle into the Chinese reform debate, and secondly, how these arguments were employed by Chinese reform economists lobbying for radical price reform in the 1980s. This second section draws on Chinese primary sources and synthesizes insights from an oral history project for which I have interviewed more than 50 Chinese and international economists who contributed to China’s reform debate. The final section concludes and summarises my answer to the research question.

2. The “Erhard Miracle” – Intellectual Origins and Post-War Reforms “The leap to a free economy is not a leap into the dark and into chaos, but instead the right step to escape chaos and to return to the natural order.” (Müller-Armack, 1974 [1948], p. 102)

Already during World War II, economists around the world devised visions and transition methods for peace time building on theoretical works of the interwar period. One common element across a variety of neoliberal contributors to the question of the peace economy is the centrality of universal and immediate price liberalisation. Hayek’s (1944) The Road to Serfdom was the most influential contribution (Backhouse, 2005, p. 368). Hayek (1944) argues that only two mutually exclusive ways of organising economy and society are possible: Either central planning, or a free society of free competition. Not only must central planning lead to fascism but any concession to central guidance would lead down this dangerous path (ibid., p. 43). Since the price mechanism is thought of as the core of competition, any state regulation of prices would obstruct the foundation of a free society (ibid., p. 38). Price control amounts to nothing less than depriving a free society of its mechanism of economic coordination (ibid., 134). In Hayek’s view price control is the “Road to Serfdom” and liberalizing prices a necessary step towards a free society.

The debate over the post-war order and price liberalisation can be considered as an extension of the Socialist Calculation Debate (SCD). Mises (1963 [1920]) had launched the SCD by claiming that rational socialism was impossible because the price problem was unsolvable without markets. As regards post-war price liberalisation Mises (1974a [1945], 1974b [1950]) argued along similar lines to Hayek: He warned that “Middle-of-the-Road Policy Leads to Socialism” and government

3 control of only a single price such as that of milk would be enough to slip into central planning and destroy free competition (Mises, 1974b, pp. 22-24).

The German ordoliberal agenda of a “social market economy” as promoted by Ludwig Erhard, the Freiburg School and others could be mistaken for such a “middle-of-the-road policy”. In fact, Hayek for example explicitly rejected the idea of a social market economy even though he welcomed the ordoliberal contribution to promoting economic freedom (Löffler, 2002, p. 80). However, as regards the central importance of free prices the ordoliberals were in complete agreement with neoliberals such as Mises and Hayek. Yet, as Walter Eucken, one of the Freiburg School architects of the West-German post-war order remarks, the conflict in Germany was not that “between laissez-faire and economic planning” (Eucken as in Nicholls, 2000, p. 185). Laissez faire had been discredited by the economic disaster of the Weimar Republic, while central planning was largely associated with the Nazis (Abelshauser, 2004, p. 89). Despite a socialist movement gaining ground across Germany, a full-fledged planned economy was not high on the agenda in the West (Freick, 2001, p. 75). The debate was instead between the social democratic proposal for a mixed economy with active state intervention (Abelshauser, 2004, 89; Nicholls 2000, pp. 179- 204) and those – like Eucken – who held that the state should merely “establish, the forms and institutional framework within which the economy must work” (Eucken as in Nicholls, 2000, p. 185).3 In terms of practical reform plans, Nicholls (2000) argues the “real conflict of opinion was between those who felt that the price mechanism must be reintroduced into Germany as quickly as possible …, and those who thought it must be severely limited in its applications so as to fulfil social and economic priorities” (p. 180).

A wide variety of proposals was discussed for how to reform the German post-war economy (Freick, 2001, pp. 37-41).4 Against the background of the experience of the German hyperinflation of the 1920s the question of price and currency control was widely debated. The allied forces had taken over the command economy and price controls from the Nazis but with the fascist bureaucracy collapsed, the chains of command and order were dysfunctional (Wallich, 1955, pp. 114-5; Zündorf, 2006a, pp. 35-42). Inflation and starvation were pervasive. The market mechanism was largely limited to the sphere of black markets and equally dysfunctional, so that the economy was left without an effective coordinating mechanism (Hansmeyer & Caesar, 1976, pp. 421-4; Zündorf, 2006a, pp. 33-4). Reflecting respective national policies, ordoliberals in favour of rapid

3 For a comprehensive collection of contributions to this debate see Möller (1961). 4 Möller (1961, p. 6) counts that there were 218 plans that are still available and another 24 of which the texts have been lost.

4 and wide-ranging price reforms tended to operate in the American zone and social democrats in favour of a more gradual release of price controls and continued direct intervention of the state were typically in the British one (Abelshauser, 2004, pp. 89-94). In 1947, George Humphrey, at the time an economic advisor to the military governor of the American zone, Lucius Clay, pioneered the proposal of a one-stroke price reform. He recommended the drastic measure of liberalizing almost all wage and price controls to erase the aggregate excess demand by inflation. Only the prices of bread, potatoes and the rent for pre-war buildings should still be controlled. However, this approach was found too risky by the US administration even under conditions of military occupation (Krieger, 1987, 377-8).

Currency reform was widely considered as a means to reduce the oversupply of money which was a result of inflationary war-financing. In this regard the most influential plan for what became known as Erhard’s 1948 reform was drafted at the request of the American military administration by the economists Raymond Goldsmith and Gerhard Colm and the Detroit banker Joseph Dodge, known as the GCD-Plan, (ibid., p. 375-77; Abelshauser, 2004, p. 122; Buchheim, 1988; Hoppenstedt, 1997, pp. 1994-210). In particular, the Jewish émigrés Goldsmith and Colm, who had worked together during their time at the Statistical Reichs Office and the Kieler Institut für Weltwirtschaft respectively, are considered the architects of this plan (Hagemann, 1999, p. 106). The GCD-Plan proposed a package of policies that should form an organic whole (Colm, Dodge, & Goldsmith, 1955). Currency reform should be combined with tax reform and entail the introduction of a new currency, while all existing monetary claims and assets would at once be reduced to 10% of the pre-reform value. Currency reform was presented as first and important step of the CDG-Plan, but the authors also warned that no measure could abolish the shortage of essential consumption goods or the black market overnight (ibid., 245).

The central German locus for the price reform debate was the Economic Council (Wirtschaftsrat) of which Erhard became director in March 1948 (Zündorf, 2006b, p. 135). Wilhelm Kromphardt, professor of social economics in Tübingen, was a strong voice on the social democratic side of the debate (Abelshauser, 2004, p. 93; Grebing, 2004, p. 392; Nicholls 2000, p. 140). He suggested a dual-system with a planned core and production for the market on the margins at a market- determined price (Kromphardt, 1947) – a model of some resemblance of the dual-track price system (DTPS) that would later emerge in China (Naughton, 1995, 220-6). On the other end of the spectrum Röpke and Eucken argued forcefully for rapid and all-encompassing price liberalisation in addition to currency reform in order to overcome what they diagnosed as repressed inflation and to achieve proportionality in relative prices (Nicholls 2000, p. 176). Other ordoliberals like the economist Alfred Müller-Armack (Müller-Armack, 1974, pp. 103-4) also rejected

5 Kromphardt’s dual-track system and called for price liberalisation, yet saw some transitional role for limited price controls of essential raw materials with inelastic supply like steel and iron. Similarly, Erhard was a renowned ordoliberal and convinced that free prices were key to the West-German recovery, and should be implemented even at high social costs (Zürndorf, 2006b, p. 134). However, Erhard was also acutely aware that given the shortages not only in key production inputs but also essential consumption goods, where demand is inelastic and the expansion of supply slow, price controls would have to be continued at least transitionally (ibid.).

On 27th June, the West-German currency reform was implemented based on the CDG-Plan. This is often described as Erhard’s reform but was essentially the making of the US military administration in coordination with the other Western allies (Abelshauser, 2004, pp. 123-6; Krieger, 1987, pp. 374-81). By contrast, to add price liberalisation to the currency reform was a decision reached by the Economic Council under Erhard’s directorship with the aim to rationalize not only the price level but also relative prices. Without the legal approval of the allied forces or the Länder Council, Erhard announced the liberalisation of the majority of prices on the day of the currency reform and found posterior backing by general Clay (Erhard, 1957, p. 23; Zündorf, 2006b, pp. 134-6). The currency reform had been carefully prepared by the allied forces, not least by the provision of imports under the Marshall plan and the toleration of hoarding. Taken together this ensured that sufficient stocks were available for the “policy of full shop-windows” (Freick, 2001, p. 71). This created the psychologically important effect that once the Deutsche Mark was introduced seemingly a miracle occurred and shop-windows filled overnight (Abelshauser, 2004, p. 127; Freick, 2001, p. 71-4; Krieger, 1987, p. 380). The sudden availability of goods that people had long craved, made the cancellation of savings and the sharply regressive redistribution of the currency reform more acceptable.

Ordo- and neoliberal economists in Germany and internationally have mystified the 1948 German currency and price reform as the creation of only one man, Ludwig Erhard, and have propagated that all prices and wages had been liberalized overnight – making the German miracle. For example Milton Friedman in a pamphlet advocating the effectiveness of shock treatment in Britain cites the “German Erhard episode in 1948” as historical evidence for the effectiveness of this policy, and writes that Erhard had “terminated all wage and price controls over one weekend” (emphasis added, Friedman, 1977, p. 45). In fact, the 1948 German price reform did not liberalize all prices and crucially kept control of the prices of essential production and consumption goods. Essential foodstuff, raw materials, rents and traffic charges continued to be subject to price ceilings for several decades to come (Zündorf, 2006b, pp. 147-157). Zündorf (2006a, 131) estimates that 30% of consumer good prices were regulated by the state in the period 1948-1963. Again in contrast to

6 Friedman’s statement, wages were also not liberalized at the same time as prices (Zündorf, 2006b, 61-2).

Instead of producing an instantaneous miracle or a short and painful but innocuous transition, the Erhard reforms invoked social unrest. Despite the congruent currency reform, aggregate excess demand caused prices to rise rapidly with the Consumer Price Index increasing by 14.3% in 1948 (Zündorf, 2006b, 61). The currency reform had annulled a large share of the wartime savings. At the same time the allied forces did not implement the GCD-Plan’s demand for redistribution of assets in order to share the burden of war destructions more equally across the population. With wages capped and prices rising, workers were facing falling real incomes on top of lost savings and were frustrated with the sharp rise in inequality. As a result, Erhard’s reforms were greeted anything but enthusiastically. Unions challenged the foundations of the new economic order: On 12 November 1948, West-German workers launched a general strike demanding economic planning and renewed price controls (ibid. 62-63). The unions’ demands remained without consequence, yet the economic fate of West-Germany was open until 1950. Erhard (1957) himself described this as “one of the most dramatic phases in German economic history” (p. 24). The Korean War finally induced a boom and set the economy on a path of export competitiveness and surpluses (Abelshauser, 2004, pp. 129, 154-74). In sum, Erhard’s price reform was clearly inspired by the ordoliberal vision for a social market economy. But it is critical to acknowledge that the prices of scarce and indispensable industrial inputs as well as of essential consumption goods were not liberalized but controlled at a low level. This in turn enabled wage restraint. Relying on cheap material and labour input, the German export model was born, which was based on partial but crucial price controls.

3. The “Erhard Miracle” in China

Mao rejected both central planning and the market as economic coordinating mechanisms during the height of the Cultural Revolution. The rural communes, the ideal of local self-sufficiency and putting revolutionary politics instead of economics in command were instead the guiding principles for organising society and economy (Riskin, 1987, pp. 163-4). But the quest for a new kind of political economy was revived in intellectual circles already in the last years before Mao’s death in 1976 (Weber, forthcoming).

As early as three years before Deng Xiaoping’s ascent to power in December 1978, which is commonly understood as the beginning of reform and opening up, a major publication was compiled by the research group on the economies of capitalist countries discussing the West-German transition experience after World War II (1975). This was not simply

7 a study in recent economic history but carried important implicit messages for China. While the book labelled West-Germany as capitalist and imperialist country as was customary at the time, the parallels with China are obvious. China had a centrally planned economy within which the chains of command and order had collapsed as a result of the Cultural Revolution just like in Germany after World War II. As the Cultural Revolution and the explicit rejection of a national economic coordinating mechanism came to an end, the question was how a new economic order could be established. So the challenge faced by China from the mid-1970s onwards was from the perspective of the need for a new economic mechanism, and abstracting from the radically different levels of industrialisation, as well as the political and ideological context, similar to that in West-Germany after the war.

But the West-German case was not only of interest to Chinese intellectuals and political leaders due to the similarity in the challenges but even more so because of the great economic success of the West-German economic recovery, the so-called Erhard Miracle. About the same time as China’s revolution and the birth of New China, Erhard implemented his reforms which were seen to have enabled Germany to rise like phoenix from the ashes of the second World War. By comparison, New China had undergone a series of attempts to push ahead to new levels of development which had succeeded in erasing the worst aspects of poverty but had failed to achieve the envisioned prosperity.

After the market had been banned as taking the capitalist road during the Cultural Revolution, reform minded economists revived Chinese debates of the 1950s and 1960s on the use of market mechanisms and the law of value in the second half of the 1970s (Fung, 1982; Garms, 1980; C. C. Lin, 1981; Liu Guoguang & Zhao Renwei, 1982; Sun Yefang, 1982). Already in 1979, Deng Xiaoping told a foreign journalist that China could develop a market economy under socialism (Deng, 1984). Some of the German ordoliberals and intellectual fathers of the concept of a social market economy were of interest in this regard. Unlike Hayek or von Mises who rejected the compatibility of socialism and the market, Müller-Armack who coined the term social market economy, takes a more pragmatic stance and argues:

“It appears to me to be a mere matter of terminology whether one calls a free market economy socialist or not. The decisive question is what order is expected to solve our social problems. If this order is the free market economy, one should have no doubt to see it as a social, or if you want so a socialist instrument.” (Müller-Armack 1974 [1946], p. 30)

8 Already Mao had started to reopen China to the West with the Nixon visit in 1972, which was followed by first delegations of American economists to China (Weber & Semieniuk, 2019). The normalization of relations between West-Germany and China followed shortly after and could build on substantial trade relations during 1949-1972 (Brick, 1985). Under Mao’s designated yet short-lived successor, Hua Guofeng, China’s opening to the capitalist World was accelerated in 1977 (Teiwes & Sun, 2011). This was Hua’s unintended yet substantial contribution to reform (Lu, 2016).

Chinese delegations were sent all around the world and the exchanges with foreign countries increased rapidly (Li, 2010, pp. 52-66). The most important of the delegations to West-Germany came in May 1978 with the visit of vice premier Gu Mu, a revolutionary and a leader of economic reform (Albers, 2016, p. 190). Gu’s mission was to study what China could learn from Germany’s economic development path (ibid., 2016, pp. 190-1; Gu, 1978). Gu’s report fuelled great interest among Chinese leaders and intellectuals in the economics underlying Erhard’s post-war reforms. The Third Plenary Session of the 11th Communist Party of China’s (CPC) Central Committee in December 1978 marked both Deng’s ascent to power and the official sanctioning of reform and opening up (Shirk, 1993, p. 39; Pantsov & Levine, 2015, pp. 341-3). One of the most pressing questions under the new agenda of putting economic development instead of revolutionary politics first, was how to rationalise the price system as a condition for the reintroduction of economic incentive mechanisms without endangering inflation. In that regard, Erhard’s reforms were considered an important lesson.

3.1. Spreading the “Erhard Miracle” in China: Visits by German Ordoliberals and Milton Friedman

Among the Chinese delegates to West-Germany were vice premier Fan Yi and vice foreign minister Zhang Wenjin. Pursuing their interest in Erhard’s post-war economic reconstruction both approached the West-German Ambassador to China, Erwin Wickert, to invite German economic experts (Meyer, 1982; Kulke, 2007). Zhang and Wickert went to school in Berlin at the same time, Zhang later studied under Werner Sombart and became interested in Marxism during his time in Berlin. The two men were friends and discussed the question of economic reform (Kulke, 2007). Wickert promptly delivered and invited Wolfram Engels, a descendant of Friedrich Engels’ brother, to China as his private guest in March 1979 (Albers, 2016, pp. 195, 296; Maxa, 1979). Engels was a prominent German ordoliberal professor of economics who shortly after his visit to China founded the Frankfurt Institute (now Stiftung Marktwirtschaft) and the Kronberger Kreis modelled on an American think tank (Pühringer, 2016, p. 13). The collaboration of those two institutions

9 was vital in preparing what is described as ordoliberal re-awakening of Germany after a social democratic period (Werding, 2008). In China, Wickert hosted a talk by Engels at the embassy for Chinese economists on the German reconstruction after the second World War. This found such great interest from the audience that several other presentations were arranged and Engels was invited for a private dinner with vice premier Gu Mu (Albers, 2016, p. 195). Wickert reported on this occasion in a telegram to Schmidt’s chancellor office:

“Gu said… that China had to combine the current system with a market economy. The question was only how this could be done. The principle that the means of production were publicly owned, however, was to be adhered to. He asked himself, if the laws of a market economy could work under this condition, to regulate economic activity. Professor Engels affirmed this and gave several examples.” (Federal Archive B136/12546 as in Albers, 2016, p. 195)

More generally, once the decision to reform China’s economy had been reached by the leadership the question of how a market system could be combined with China’s planning system became dominant over the question of whether or not to use the market (Weber, forthcoming). In this regard, the West-German reforms were one important lesson.

In his presentations Engels gave an implicit answer to the question how a market economy could be created. Engels’ key message was that the West-German Miracle could be replicated in China by implementing policies akin to what he saw as Erhard’s reforms, i.e. drastic stabilisation policies combined with radical and universal overnight price reform. Engels’ told his Chinese audience that while post-World War West-Germany was undergoing a period of unprecedented prosperity, the actual economic miracle was short, unpredicted, and induced by the 1948 currency and price reform.5 Engels attributed the sole responsibility for the miracle to Erhard. He argued that after the war the allied powers had continued the planned economy of the Third Reich. Putting an end to this system had been decisive for West-Germany’s fate. Lacking a democratic government and with increasingly strong political voices for the nationalisation of all industries and planning, it had been Erhard’s great contribution to establish a free market economy. Liberalisation of prices was necessary for a free market economy. In contrast to Erhard’s cautioning in relation to essential consumption goods and production inputs discussed in the previous section, Engels blamed the

5 This section is based on one of Engels’ speeches on the West-German economic development in China that was published upon his return in German in the Wirtschaftswoche (Economic Weekly, 21 May 1979), of which Engels was the editor in chief. A Chinese translation came out in the journal European Research five years later (Engels, 1984), when the question of price reform was hotly debated among political leaders and economists.

10 fact that the prices of essential raw materials like coal, steel, and iron had not been liberalised on the orders by the military occupation. But despite these constraints and in contrast to the mixture of socialist planning and Keynesianism that dominated in post-war U.K. and the U.S.A., Engels argued, the German Miracle had helped spread free market thinking across the world.

Soon after Engels another German ordoliberal economist, the director of the HWWA - Institute for Economic Research, former member of the German Council of Economic Experts and founding member of the Kronberger Kreis, Armin Gutowski, and his wife, Renate Merklein, an editor at Der Spiegel, were invited to China in July 1979 (Albers, 2016, p. 196; Gutowski, 1979; Merklein, 1980). Gutowski continued the same line of argument as Engels, but was more subtle in adapting his message to the Chinese context and thus found even greater appreciation by Chinese reform leaders and economists. Gutowski was made an advisor to the Chinese government – some argue the first Western economist in this role (Kunkel, 2006) – returned to China repeatedly and received high-ranking Chinese delegations until his early death in 1987 (Fan, forthcoming).6

In a 1979 speech that was published in Chinese in the journal World Economy （世界经济）, Gutowski (1979) like Engels stressed the critical importance of Erhard’s price and currency reforms for the West-German economic recovery. He described the immediate post-war German economic challenges in terms that must have sounded familiar to the Chinese audience: There was severe aggregate access demand since production had been aimed at supplying material for the war effort and not consumption goods and with most goods still rationed money was of restricted use other than on black markets (p. 37). In China, a somewhat similar situation had resulted from a heavy-industry focused socialist planned economy. Gutowski acknowledged that the immediate aftermath of Erhard’s reform saw high inflation but failed to mention the general strike. Instead he claimed that the inflation had been without serious consequences since people had been aware that it was a transitional phenomenon (ibid.). The omission of the general strike and inflation was important since triggering social unrest was a major concern for Chinese leaders in reforming the economy.

During a subsequent visit Gutowski (1982a) moved from describing the West-German experience to drawing lessons for China and explicitly addressed the question of the compatibility of the market and socialism. In 1979, Gutowski had argued that the reason for Erhard’s reform success was because they achieved the establishment of a new free economic order based on competition

6 The Xue Muqiao Chronicle contains detailed information on the dates and procedures of Gutowki’s visitis to China.

11 (ibid.). Some would have it that a market economy implies capitalism, Gutowski (1979) said, but the German proponents of a social market economy had rejected this view by pointing to the public provision of social welfare (p. 38). In 1981 Gutowski spelled out his position on the relationship between the market and socialism. Gutowski (1982a) sided with Lange’s position in the SCD and said: “public ownership can remain unchanged, but there must be competition for economic vitality” (p. 14). For competition in turn, besides supressing inflation, price reform was essential just like the example of Erhard’s success had shown. Based on this logic, Gutowski (1982a) proclaimed that the rationalisation of the price system would decide success or failure of China’s economic reform (p. 12).

Gutowski’s emphasis on the compatibility of competitive prices with socialism resonated with some of China’s most prominent economists of the first generation of revolutionaries, such as Xue Muqiao, who had argued since the late 1950s for enhancing the role of the law of value under China’s socialism, or in other words to increase the reach of competitive prices as regulating mechanism (Fan, forthcoming). In fact, Xue and Gutowski were in close exchange and Xue organised some of Gutowski’s visits to China (Gutowski, 1982a), while Gutowski arranged for Xue’s (1981) major contribution to reform thinking to be translated into German (Fan, forthcoming; Xue 1982). In Gutowski’s preface to the German translation, he stressed that even though Xue started from a Marxist outlook, they had arrived at very similar conclusions as regards the question of China’s reform (Gutowski, 1982b).

A third important ambassador of the Erhard Miracle in China was Milton Friedman (Friedman, 1981, 1990). Engels and Gutowski made some claims regarding the origins and consequences of the West-German currency and price reform that do not withstand closer economic history scrutiny. Friedman took the mystification of the West-German reforms as Erhard’s Miracle to a new level. Before coming to China, Friedman had already invoked the West-German post-war recovery as evidence for his shock treatment of rapid liberalisation backed by budget cuts, in Pinochet’s Chile and Labour’s Britain (Friedman, 1977, p. 529; Friedman Milton, 1998). As part of the Chinese reformers’ policy of “opening the minds to the outside world”, Milton and Rose Friedman were invited to China in 1980. During his first visit, Friedman told his audience at the Chinese Academy of Social Sciences:

12 “The so-called economic miracle produced by Ludwig Erhard in 1948 was a very simple thing. He abolished all price and wage controls and allowed the market to operate while at the same time keeping a strict limit on the total quantity of money issued.” (Friedman, 1990)7

Friedman acknowledged some transitional inflation immediately after the 1948 reforms, but as monetarist he argued that a relative increase in the quantity of money was the only cause of sustained inflation. As long as the quantity of money was controlled, an increase in the price of one commodity must always be compensated by a relative decrease in other prices and was as such negligible. Friedman ruled out the validity of cost-push inflation theories and did so with reference to Erhard’s reforms (Friedman, 1990).

In fact, Friedman’s claim that Erhard had eliminated all price controls is simply false. As we have seen, the prices of essential production inputs as well as of basic consumption goods were not liberalized as a result of Erhard’s own caution and wages were also not liberalized at the same time as prices. This is important, since a forceful source for cost-push inflation would have come from essential production inputs like steel and coal, which were scarce and for which the demand was inelastic. Similarly, the supply of basic consumption goods was limited and demand inelastic, so if these prices and wages had not been controlled it could have caused a wage-price spiral and sustained inflation. As we will see in the next section, it was precisely the danger of cost-push inflation and a wage-price spiral that was upheld in China against emulating what came to be stylized as Erhard’s radical price reform.

Unlike the visits by Engels and Gutowski, which were the starting point for repeated exchanges, Friedman’s 1980 tour in China remained without commitments from the Chinese side. Friedman did take the analysis of the Erhard Reforms to a new level of theoretical sophistication by interpreting it from a monetarist viewpoint compared to the more anecdotal contributions by Engels (1984) and Gutowski (1979). But he did so at the cost of historical accuracy. It seems likely that Friedman’s presentations did not fit with Deng Xiaoping’s new paradigm of “seeking truth from facts” (Deng Xiaoping, 1984a). Deng called to reject any form of doctrinaire approach and warned: “Once people’s thinking becomes rigid, book worship, divorced from reality, becomes a grave malady.” (Deng Xiaoping, 1984b, pp. 153-4). In this context, Friedman’s portrayal of Erhard must have appeared to lack realism. Facts were bent to fit his monetarism, instead of trying to understand the historical experience and then draw lessons for the Chinese context.

3.2. The Erhard Miracle in the Chinese Price Reform Debate

7 Friedman (1990) is only available as a e-book without page numbers.

13 The Chinese price system had been frozen during the Cultural Revolution (1966-1976). Thus even by the standards of the previous Chinese practice of price regulation, which was always more experimental than scientific compared to the Soviet Union, prices in the late 1970s were widely “irrational”, in the sense that they were not based on any consistent accounting logic. Readjusting the price system was therefore a priority. Already in 1978 the relation between agricultural and industrial prices was adjusted to improve the terms of trade for agriculture. Furthermore, the agricultural reforms which saw the abolishment and the rise of the household responsibility system, created a DTPS: the quota that had to be delivered for the state plan was enumerated at the state- set price, but all output beyond the quota could be traded on the recreated markets at competitive prices. As enterprises were granted increasing autonomy, a similar system emerged for non- essential industrial goods, light industry in particular. So in the first years of reform the price system was both adjusted by central command and the market as new regulating mechanism was introduced at the margins of the system. But a wide-ranging or even universal one-stroke overnight liberalisation emulating the Erhard price reform was not implemented, even though some reform leaders and economists as well as the World Bank and other foreign advisors thought that this was the best solution and necessary for China’s economic system reform (Weber, forthcoming).

By 1984, the agricultural reform had achieved an overwhelming success in terms of increasing grain output and the focus was increasingly on the reform of the industrial core of the urban economy (Naughton, 1995, p. 138-41). At the same time, it was officially sanctioned that price reform would be the key to China’s system reform – just as Gutowski and others had argued (Fan, forthcoming). But instead of implementing an Erhard-type reform, the DTPS for industrial goods, in particular heavy industry and key industrial inputs, was officially sanctioned. Turning the DTPS that had emerged more or less spontaneously into a national policy was the reform approach promoted by young economists with a background in agricultural reforms as well as by more cautious older generation reformers (Liu, 2010).

The official establishment of a DTPS meant that those who had lobbied for radical price reform in one package lost out – at least temporarily. These were in particular, middle-age economists who were the first to be trained in modern microeconomics, as well as young scientists who contributed to the reform debate (Weber, forthcoming). To launch a counter attack and attempt once more to push through price reform in one go the mid-1980s saw a great revival of discussions of Erhard’s reform. These included articles in the leading journals for the debate of economic system reform such as Comparative Socioeconomic Systems (经济社会体制比较, e.g. Ren, 1985; Yue, 1987)，influential literary magazines like Reading Books (读书, e.g. Zhang & Wu, 1986)， and China’s top economics journal Economic Research (经济研究, e.g. Chen, 1985).

14 One of the prominent voices in this campaign was Wu Jinglian (2016). Some scholars of China’s reform have stylized Wu as “The Voice of Reform” (Naughton, 2013, emphasis added) notwithstanding that Wu was firmly rooted in only one reform camp that was fiercely contested by other market reformers who believed in the DTPS and gradualism more broadly. In May 1985, Wu (1985a) extended on a previous article in People’s Daily (Wu, 1985b) in Economic Research and laid out his vision for reform. Comparing a gradual to a package (一揽子) approach, Wu recommended the latter. A duality of elements of the old and the new system was unavoidable in the transition but should be overcome as quickly as possible, in particular price reform had to set an end to the DTPS. To make his main point, Wu quoted Friedman’s 1981 talk in China that the “so-called economic miracle produced by Ludwig Erhard in 1948 was a very simple thing” (Friedman, 1990; Wu, 1985a, p. 4). According to monetarism – which Wu had been taught during his visiting studentship at Yale to be the state of the art economic theory which had refuted Keynesianism – and based on the post-World War II German experience, Wu argued, it was critical to tightly control the quantity of money and impose fiscal austerity in order to prevent inflation, which was in turn a sufficient condition for swift price reform. Wu was certainly not alone with this view even though he is one of the Chinese economists better known abroad. Some collaborators of Wu from the younger generation of scholars were for example Guo Shuqing, Liu Jirui, Qiu Shufang and , many of whom came to hold top government positions later (Weber, forthcoming).

The campaign for macroeconomic restraint and wholesale price reform gained support of great symbolic value from participants in a major conference co-organized by the World Bank, which was held on the MS Bashan cruising the Yangzi River from 2 to 7 September, 1985 (Liu Guoguang & Zhang Zhuoyuan, 1985, p. 3; Guo Shuqing, 1985). Once more the Erhard miracle was invoked as proof for the effectiveness and feasibility of a big bang. The delegation included the recent Nobel Laureate James Tobin, the rising star of socialist economics Janos Kornai, the Polish émigré economist and market socialist Wlodzimierz Brus, Alec Cairncross, who had contributed to the British post-World War II transition as economic advisor, and the former director of the Bundesbank (1976-9) Otmar Emminger, who had helped shape the German monetary policy since 1950 (Emminger, 1986, p. 14). Some prominent Chinese participants included An Zhiwen, Gao Shangquan, Xue Muqiao, Ma Hong, Liu Guoguang, Zhao Renwei, Wu Jinglian, as well as Tian Yuan, Lou Jiwei, Guo Shuqing, and Luo Xiaopeng from the younger generation (Lim, 2008; Liu Hong, 2009; Wood, 1985).

At a dinner with premier Zhao Ziyang before the conference participants embarked on the boat, wage and price reform were the “cardinal issue raised by the Prime Minister” (Cairncross, 1985b).

15 Whereas Tobin cautioned “China should do better than any of us and devise new institutions”, Emminger once more recommended following the West-German path (ibid.). In line with Friedman and Wu Jinglian and in agreement with Kornai, Emminger “emphasised Erhard’s bold stroke in abolishing price controls at one go in 1948” (ibid.). Later, during the conference on the boat, Cairncross set the British experience against the German “miracle” and called for a gradual decontrol of prices (Liu et al., 1987, p. 14). Under China’s conditions, in Cairncross’ view, “monetary policy will be impotent and the effect of budgetary control will also be limited” (ibid.). Furthermore, market regulation relied on quantity adjustments in reaction to price changes but if, as in China given its low level of development and the institutional structure of a planned economy, “supply and demand are inelastic in terms of price changes, then administrative control can achieve what the price mechanism cannot” (ibid.). But despite Cairncross’ and Tobin’s cautioning, a momentum for radical price reform of the type attributed to Erhard was building up in China also after the Bashan conference. In 1986, premier Zhao Ziyang set up the so-called Programme Office which was meant to prepare a radical price liberalisation combined with wage and tax reform. In the same year, Gutowski was once more consulted by a Chinese delegation to West-Germany headed by the Deputy Director of the State Economic Commission Zhu Ji. Gutowski again urged for price liberalisation based on the Erhard Miracle (Gutowski, 1986). But the plan drawn up by the Programme Office was ultimately not implemented (Programme Office, 1986; Wang, 2017; Wu, 2016). One important reason was that Wang Xiaoqiang, Chen Yizi and other economists from the Economic System Reform Institute, China’s first reform think tank, warned forcefully against this step (Wang, 2016; Wang, 2017). Based on their in-depth fieldwork in China, Yugoslavia and Hungary, they warned of cost-push inflation and a wage-price spiral given China’s monopolistic production structure, the new autonomy of enterprises in wage setting and the prevailing soft budget constraints. Inflation again would have severe social and political implications and could endanger the project of reform (Chen Yizi et al., 1987; Reynolds, 1987).

After the aborted plan for one stroke price liberalisation in 1986 the lobbying for such a plan continued. In 1988, Deng Xiaoping personally took initiative to launch another attempt at far- ranging one-stroke price liberations. But only the propaganda to prepare such a reform was enough to cause mass panic and caused people to spend their savings on whatever durables they could get hold of. The loss of trust in the value of money caused the first episode of hyperinflation in China since the civil war hyperinflation had been brought under control shortly after the revolution. To contain the damage the plans for radical price liberalisation were stopped in the summer of 1988 and economic system reform was put on hold (Naughton, 1991). In a last attempt, to revive the

16 plans for a great push in price reform, Milton Friedman was once more invited to China. Wu Jinglian and others briefed him before his meeting with Zhao Ziyang in hope that the authority of the Nobel Laureate could make a difference (Peng, 2016). Friedman ( 1988, 1990) once more invoked the wonders of the Erhard Miracle and urged his Chinese audience that only radical price reform could prepare the grounds for an efficient new economic system. But this remained a vain effort and China ultimately escaped a big bang in price reform but nevertheless produced its own miracle.

4. Conclusion

In conclusion, three distinct dimensions aroused interest among Chinese intellectuals and reform leaders in the so-called Erhard Reform and were the motivation for an intense exchange with ordoliberal and neoliberal economists about the question of price reform from the late 1970s onwards. Firstly, the unexpected economic success of West-Germany after the destructions of the Second World War appeared like the sudden break-through that the Great Leap Forward and Big Push Industrialisation more broadly had hoped to achieve but failed to deliver. This appearance does not hold up to scrutiny and it is highly contested whether the post-war boom was the making of some leap into the dark or whether the strong industrial foundations and foreign assistance was more crucial (Abelshauser, 2004, pp. 67-9; Galbraith, 1981, pp. 192-206). But notwithstanding this historical inaccuracy, the West-German economic boom – especially in its mystified representation as miracle – resonated with the Chinese attempt to achieve rapid economic development.

A second dimension was the similarity in the technical challenge of how to deal with price controls. From a technical point of view the problem faced after the war was similar to that at the beginning of reform in China. In both cases the chains of command and order in a centrally planned command economy had collapsed – of course for radically different reasons. In both cases, the question was how to create a new economic order that should allow a greater role for market mechanisms. But market competition requires some degree of price flexibility and the question was how to achieve this and what degree was necessary. In this regard, the radical West-German 1948 price reform was a relevant experience for China.

Thirdly, despite the vastly different ideological context in West-Germany just after the war and in China after the Cultural Revolution, the ordoliberal vision of a social market economy spoke to China’s debate over the compatibility of socialism and the market. The ordoliberals insisted that a market economy would not imply full-fledged capitalism and could instead be combined with socialistic principles. Some, like Gutowksi, even explicitly sided with Lange against the neoliberals on the subject of the Socialist Calculation Debate.

17 This paper has documented presentations by the German ordoliberals Wolfram Engels and Armin Gutowski as well as by Milton Friedman on the Erhard Miracle in China. In the beginning, this took mainly the form of a case study of the West-Germany post-war reform driven by the hope on the part of Chinese leaders and economists to draw lessons for China’s own search for reform. But the West-German experience was increasingly transformed into a metaphor for the success of a radical price reform under the label of the Erhard Miracle. The Erhard Miracle came to play an important role in China’s fierce reform debate as anecdotal evidence for the possibility of a magical solution to the complicated problem of price reform. In this process, the historical details, especially the critical question of the range of the price reform and the continuity in controls of essential consumption goods and industrial inputs, was more and more brushed away. The Erhard Miracle came to stand for the wonders of overnight and all-encompassing price reform as invoked by Friedman. Such a radical one-stroke reform was repeatedly prepared but never implemented in China. From the mid-1980s on, a group of economists was campaigning for radical price liberalisation and in their narrative the Erhard Miracle occupied a prominent place. This was once more the case in 1988, after an aborted attempt at far-ranging price reforms, when Friedman came for a second time to China hoping to assist the Chinese to finally push through with what came to be called a big bang in the context of shock therapy in Eastern Europe and Russia.

In sum, the Erhard Miracle became a forceful metaphor for radical price reform in China. Such a price reform was ultimately not implemented yet the struggle in the 1980s was fierce and China escaped a big bang by a whisker. Interestingly, the actual price structure that emerged from the DTPS with low state-controlled prices for essential consumption and production goods and relatively low wages at its core, while all other prices were largely subject to the market, is surprisingly similar to that of the West-German post-war economy. The similarity between China’s 1980s and Erhard’s 1948 price liberalisation thus does not lie in the method of sudden liberalisation but in the pattern of what kind of prices were released and what kind of products continued to be subject to the state’s price control. In this regard, there is great parallel. References

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