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Did High Wages or High Interest Rates Bring down the Weimar Republic?
Hans-Joachim VothThe Journal of Economic History, Vol. 55, No. 4 (Dec. 1995)
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Pre-war Germany• Dynamic Economy, high Saving and Investment– 16% of domestic product devoted to capital formation
• Virtually no unemployment
1920s• Deterioration of economic confidence
HYPERINFLATION
• Stabilization of currency in 1923 prosperity, rising output, exports, and employment
• Signs of economic weakness in late 1920s investment dropped to 10.5% of GDP
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Insured ^
: Unemployment overstated in these statistics; employment grew rapidly, driven by increased exports
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• Limited investment primary reason for slump caused by either:– Excessive wages reduced profits (Borchardt thesis)– High interest rates undermined capital expansion (Voth)• Capital inflows threatened renewed inflation• Hjamar Schacht pursued a tight monetary policy which kept
interest rates high (sterilization of capital inflows)
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As unit labor cost increased, expansion rate of capital stock decreased (after 1930).
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VothThe relationship between interest rates, real wages & investment is causal:• Prices of capital and labor determine the rate of expansion of
capital stock.Borchardt’s view: high price of labor discouraged investment because it squeezed firms profits• But high labor cost might encourage investment – Substitute capital for labor
Additionally, even had wages been constrained, investment would have been below historical levels by about 1/3
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• Error-correction model reveals no evidence of wages depressing investment
• Demand for capital in the German economy between 1925 and 1929 strongly reduced by high interest rates
• Simulation suggests that lower interest rates at the end of the 1920s would have caused significantly higher investment
• Strong substitution effects between capital and labor High wages make for high investment relative to capital stock
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Voth’s Conclusions
• “If, as Schumpeter suggested, domestic capital formation was crucial in determining the overall economic performance on Weimar Germany, the interest rates and not wage pressure were at the heart of sluggish growth”
• “Whatever may have been necessary to save the first German republic, the small-cake economy that- according to Borchardt- was directly responsible for its demise could hardly have been avoided through workers’ sacrifices. Instead, possible remedies for Weimar’s malaise of low investment could have been higher wages, or a return to the lower interest rates that had prevailed before WWI.”