Gustav von Schmoller (June 24, 1838 – June 27, 1917) was the leader of the "younger" German historical school of economics. He was very influential in German academia in the latter part of the nineteenth century, from his position at the University of Berlin he resurrected German Historicism and ruled the German academic world of economics for several decades.
Schmoller rejected the analytical and mathematical approaches to economics of Classical and Neoclassical theory, proposing instead that it be studied in the context of the other social sciences, including history and ethics as well as sociology, social psychology, social anthropology, and geography. He regarded economics as inherently a normative discipline whose purpose should be the development of tools for use by policymakers and businessmen. Severely criticized by theoretical economists such as Carl Menger, and with few of his works translated into English, Schmoller's influence in economics was mostly limited to Germany. Had his economic thinking been institutionalized in the United States and Europe, in all probability the recurrent world economic crises of the early twenty-first century could have been reduced to mere relics of the nineteenth century.
Gustav von Schmoller was born on June 24, 1838 in Heilbronn in northern Baden-Württemberg, Germany. His father was a civil servant. Young Gustav studied Staatswissenschaften (a combination of economics, law, history, and civil administration) at the University of Tübingen (1857–1861).
In 1861, he obtained an appointment at the Württemberg Statistical Department.
In the early 1860s Schmoller gained favor with Prussian authorities through his defense of the commercial treaty between France and the German Customs Union. He became a member of the Prussian state council in 1884, was appointed the official historian of Brandenburg and Prussia in 1887, and served as representative of the University of Berlin in the Prussian upper house in 1889.
In addition to publishing several books, including his magnum opus Grundrisse der Allgemeine Volkswirtschaftslehre (Outline of General Economic Theory) published 1900-1904, Schmoller was editor of the Jahrbuch für Gesetzebung, Verwaltung, und Volkswirthschaft im deutschen Reich. From 1878 to 1903 he edited a series of monographs entitled Staats- und sozialwissenschaftliche Forschungen. He was also an editor and major contributor to Acta Borussica, an extensive collection of Prussian historical sources undertaken by the Berlin Academy of Science upon Schmoller's instigation.
Gustav von Schmoller died in Bad Harzburg on June 27, 1917, aged 79.
Gustav von Schmoller was an outspoken leader of the "younger" historical school, and opposed what he saw as the axiomatic-deductive approach of classical economics and, later, the Austrian school. Indeed, Schmoller coined the term to suggest provincialism in an unfavorable review of the 1883 book Investigations into the Method of the Social Sciences with Special Reference to Economics (Untersuchungen über die Methode der Socialwissenschaften und der politischen Oekonomie insbesondere) by Carl Menger, which attacked the methods of the historical school. This led to the controversy known as the Methodenstreit (Battle of Methods), which was one of the main reasons for the later demise of the whole historical school.
However, it is often overlooked that Schmoller's primary preoccupation in his lifetime was not with economic method but with economic and social policy to address the challenges posed by rapid industrialization and urbanization. That is, Schmoller was first and foremost a social reformer.
He was greatly concerned, not to say upset, about the fast-growing inequality of income and property distribution. ... He felt that the social consequences of rapid industrialization had thrown Germany into ... "a class-struggle situation." ... "economic freedom" was a cliché because there could be no competition between a lord and a landless peasant. ... He did not believe that history worked itself out as a natural process; but rather that man must help by proper legislation.”
Since the 1980s Schmoller's work has been reevaluated and found relevant to some branches of heterodox economics, especially development economics, behavioral economics, evolutionary economics, and neo-institutional economics. He has long had an influence within the subfield of economic history and the discipline of sociology.
Schmoller was a leading Sozialpolitiker (more derisively, Kathedersozialist – "Socialist of the Chair"), and a founder and long-time chairman of the Verein für Socialpolitik, the German Economic Association, which continues to exist. He was also an outspoken proponent of the assertion of German naval power and the expansion of German overseas empire. Schmoller's influence on academic policy, economic, social and fiscal reform, and economics as an academic discipline for the time between 1875 and 1910 can hardly be overrated.
Gustav Schmoller's political involvements were also important: In 1872, he formed the Verein fur Sozialpolitik, ("Society for Social Policy"), a group of largely conservative economists which supported a kind of corporatist state-industry-labour nexus. In the meantime, actual Socialists and Marxians regarded Schmoller's group as an instrument of government and businesses to control and mollify the working classes. This was often confirmed as Verein rarely opposed an economic policy decision by the Imperial German government, finding ways to justify Bismarck's policies.
Von Schmoller’s greatest work is Grundrisse der Allgemeine Volkswirtschaftslehre (Outline of General Economic Theory), the most massive attempt in the literature to capture historical laws in a systematic treatise. Published between 1900 and 1904, Schmoller's Grundrisse utilized a historical and ethnological approach to such topics as the medieval guild system), urban development, and banking. As Schumpeter noted, "the Schmollerian economist was essentially a historically minded sociologist." In fact, Schumpeter noted that in the Schmollerprogram he found the "outlook of a universal social science."
However, the impact of Schmoller's antagonism to the abstract theoretical approach to economics was detrimental to economics in Germany. His influence was such that hardly any significant academic post in economics was filled without his approval, and the result was that advances in economic theory passed the German economists by for several decades.
Schmoller's opposition to neoclassical economics entered him into a famous methodological debate (Methodenstreit) with Carl Menger. Much of the fight amounted to tilting at windmills, since it was an argument over precedence and the relative importance of theory versus history. Whereas Schmoller hoped to integrate ethics within economics in order to improve its empirical basis, Menger wished to identify the different behavioral mechanisms linked to the economic and the ethical perspectives, and therefore wanted to keep them separate wherever possible.
While Schmoller and Menger provided strictly antagonistic accounts of how ethics and economics should be related, their contentions were mainly methodological. In fact, Joseph Schumpeter pointed out that this was really a quarrel within the school, "substantially a history of wasted energies, which could have been put to better use."
Schmoller's approach was characterized by his focus on the interaction between ethics and economics as well as the importance of historical study. According to Schmoller, concrete historical research must precede the creation of an economic theory, since only an historical approach makes it possible to determine the causal relations between social phenomena. The behavior of economic entities (individuals and groups) results from the interaction of a variety of factors; therefore, economic science should concern itself with, for example, the intentions of individuals considered as economic units, the level of technological development, the character of existing social institutions, and natural conditions. Schmoller suggested that political economy, as the basic social science, encompasses such disciplines as psychology, sociology, and geography; it is therefore normative and provides a basis upon which to make ethical judgments and practical recommendations.
Backhaus noted six features of Schmoller's economic approach:
Some specific aspects of his approach include:
For Schmoller, the great economic miracle was not the autonomous interplay of market forces but the cooperation of human beings in social institutions (which he calls Organe) with common values, languages, and so on.
Schmoller distinguished social systems in the family, communities, and the business. Economic institutions are to be understood as not only technical but also psychological and ethical, since the social context within which they operate functions based on ethical and moral values. Thus, economic life cannot be understood without knowledge of the historical development of customs, laws, and morals: "Economic behavior and economic institutions [should be derived] from psychological power in general, from sentiment and instinct, from ethical ideas, and economic behavior should be grasped in the framework of morals, custom and law." Schmoller developed a modern socialization theorem that took into account Adam Smith’s concept of sympathy. He held a dialectical homo duplex model: man is driven both by rivalry (an individualistic tendency) and by the need for social acceptance. Likewise, in all institutions, double impulses are at work.
Schmoller saw markets as “merely” a set of institutionalized rules with no logic of their own:
Competition has no inherent tendencies other than those implanted in the specific working rules of society ... an artificial arrangement supported by the moral, economic, and physical sanctions of collective action.
Schmoller did not assume markets free of transaction costs with an abstract auctioneer, and he was not a “value essentialist.” Specific prices are given; haggling and bargaining (Marktfeilschen) set in. Actors are not really sure about the bid and thus ask for prices: they make unsure forecasts on supply and demand (curves). The spot prices need interpretation, and a general, but time- and space-bound, qualitative hermeneutical knowledge is essential:
Actors have to know the extension of the market and its relations, ... as well as ... the manner of its provisioning (if it happens once a year or without interruption). ... they must know where and at what time the main part of supply is concentrated, e.g., in specific storehouses, special auctions; they have to know the interplay of different markets.
Usually the result of transactions depends on knowledge, material reserves, financial capacity, the level of information, education, motives, and the capacity to withhold (Geschäftsdringlichkeit). With all these elements taken together, diverging power positions are established, as is price-setting behavior. Full competition, understood as equality of power, is but a special—and in Schmoller’s time an improbable—case.
According to Schmoller, the function of the state is to establish an order (general education, the freedom to strike, and so forth) to make the opposing market sides more equal and then let collective and cooperative bargaining do its job in the regulation of the market process. Here the function of the state should be minimized, defining the rules and making the market process a trust, creating a win-win game. The result is “collective action in control, liberation and expansion of individual action.” This is the idea of the social market economy from the perspective of the historical school.
International trade engenders economic, political, and cultural problems, as well as the problem of social integration. This requires regulatory policies and a synthesis with market forces. Thus, international markets are not be defined as natural and autonomous processes but rather as systems of institutionalized rules—Schmoller's definition.
Efforts to apply Schmoller’s ideas to current, pressing economic policy problems have been, and continue to be, deficient. Yet these issues must be resolved in order for human society to flourish in the future. Marginal adjustments are not sufficient; it requires a change in the target of the system, with a reversal of values and customs, different legal systems, economic structures with built-in limitations to wealth and acquisition, new educational norms—in short, a qualitatively new stage in economic thinking that includes a wide range of fields. Taking these interdisciplinary actions into consideration to make realistic and rational “informed decisions” about the best policy in a holistic manner, then Schmoller may yet become a star of the first importance among the famous economists.
An example of Schmoller’s probable handling the 2007 banking crisis emanates from the above paragraphs. Reasons for the decline in U.S. competitiveness are not hard to find. It is no secret that excessive regulation, such as excessive taxation of any business or industry, can seriously weaken it. The Sarbanes-Oxley Act of 2002, enacted as a reaction to a number of major corporate and accounting scandals including those affecting Enron, Tyco International, and WorldCom, set new or enhanced standards for all U.S. public company boards, management and public accounting firms. These standards placed extremely costly financial burdens and are estimated to have cost $1.4 trillion in lost market value of U.S. companies.
As the regulations—higher tax burden, retroactive penalties, more frequent inspections, increased licensing requirements—restricted profitability, the banking sector became highly under-capitalized, as many prospective clients moved to off-shore banks. The banks responded by developing instruments that avoided higher reserves by moving risky loans off their balance sheets and selling them as “assets” to other banks. Thus, the risk, in the form of sub-prime mortgages “assets” packages, moved to all corners of the global marketplace.
Schmoller's suggestion, that the function of the state should be minimized, limited to defining the basic rules and making the market process one of trust, would have prevented this situation. In view of Schmoller’s institutionalized rules, what was needed was not a multitude of new regulations, but just a few reasonable status-like federal rules, that would safeguard both parties from collapse: the clients and the bank itself. For example, if a loan is made to someone to buy a house, then there should be a necessary (and legal) requirement for a certain minimum down payment (ten percent, for example). Then when a house loses value the temptation to walk away from the mortgage and forfeit the house is much less, since the buyers put substantial real money into the house.
Gustav von Schmoller's legacy is mixed. His dominance of field of economics in Germany for several decades was a powerful force, but a mixed blessing. His adamant opposition to the theoretical approach of classical economics and the Austrian school not only led to the time consuming, and basically fruitless, Methodenstreit with Carl Menger, it also severely limited the development of economics in Germany to the historical approach. Not only that, but his work was basically unrecognized outside Germany, a situation exacerbated by the lack of translation of his works. Yet, his work had much to offer, both then and now.
Since the 1980s Schmoller's work has been reevaluated and found relevant to some branches of heterodox economics, especially development economics, behavioral economics, evolutionary economics, and neo-institutional economics. Schmoller's own writings clearly define him to be a social economist, easily amended into making him a behavioral economist in the vein of Amos Tversky and Nobel laureate Daniel Kahneman, whom he predated by more than 100 years. His implicit holistic approach to the study of economics—inclusive of his interest about the global climate, social conditions and co-operations—mirrors that of economic experts in developing and lower-income countries.
The most frequently asked question in these days is: Why are many developing countries (particularly in Africa, Central Asia, but in Eastern Europe and the Balkans as well)—despite billions of dollars in aid being thrown into their “coffers”—still at, basically, the same level of “underdevelopment” with little improvement in standard of living, and often more politically polarized than before? Schmoller’s view (based on his historical research of long-gone economies) is that the function of the state should be minimized, limited to defining the rules and making the market process one of trust. This is exactly what is missing in the most of the world’s developing countries, low income countries, and even some of the new EU member countries. These old oligarchies and “royal sovereigns” eschew all international legal statuses with the result that much of the international aid goes to the rulers' off-shore bank accounts. Schmoller’s “rules” (in other words, laws that apply to everybody and are strictly upheld in the socio-political climate of the given country) is a necessary condition that generally most donor organizations have not understood. This understanding could be Gustav von Schmoller’s epitaph and a reason for his immortality among the great economic thinkers of all time.
One of the reasons why Schmoller is not more widely known today is that most of his books and articles were not translated as during his time Anglo-American economists generally read German, which was the dominant scholarly language of the time. Only three articles, a booklet on mercantilism, and a condensed version of the Grundriss were translated into English. The untranslated texts are now inaccessible to readers without knowledge of German.
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