During the past two decades there has been a heated debate about the causes of the German so-called Wirtschaftswunder (economic miracle) after the Second World War. This debate came somewhat unexpectedly, as the German war generation always took it for granted that the impressive growth record in the 1950s and 60s was a consequence of economic liberalization after 15 years of tight planning and state interventionism under the Nazi dictatorship (Buchheim 1989). (1) Indeed, after the introduction of the Soziale Marktwirtschaft (social market economy) in 1948, Ludwig Erhard, the first federal economics minister, enjoyed a legendary reputation. Nevertheless, Erhard never saw himself as a "miracle man." He always emphasized that Germany's rapid growth was due to a sound economic policy, in particular the implementation of a free economic system (Erhard 1958). (2)
In the 1980s, this view was challenged by historians and economists who argued that Germany's postwar growth was essentially the result of a reconstruction boom after the lost war. The main German advocate of this reconstruction theory was the historian Werner Abelshauser (1983). He questioned the impact of the currency reform--a core ingredient of Erhard's economic policy--on economic growth. Rudi Dornbusch also questioned the conventional view. He pointed to the Japanese experience in achieving strong economic growth in the 1950s and 60s "in an environment where competition and liberalism were decidedly absent," and argued that France performed nearly as well as Germany "with a system far away from German liberalism" (Dornbusch 1993: 882). Dornbusch is wrong for two reasons. First, Japanese growth was highest in the 1960s, not in the 50s when the income gap was largest. Second, France's growth rates did not approach those in Germany, which were much higher.
Solving the Controversy
Crude theories linking exceptional growth to war devastations were originally formulated as early as in the 19th century. In 1848, John Stuart Mill (1848: 93) wrote: "An enemy lays waste a country by fire and sword, and destroys and carries away nearly all the movable wealth existing in it; all the inhabitants are mined, and yet, in a few years after, everything is much as it was before." More than 100 years later, K.C. Kogiku (1966: 154) explained Japan's high postwar growth in terms of "Friedman's Law": "Destroy the greater part of a nation's fixed capital in war activity and dislocate the whole economic structure. Eventual recovery from this chaotic state of affairs will be rapid, giving a growth rate of 8-10 per cent annually." This is indeed the rate of growth Germany experienced in the early postwar period. (3)
Turning to formal growth theory, reconstruction booms can be easily explained with the standard neoclassical model originally proposed by Solow (1956, 1957). Assuming Harrod-neutral technical progress, the long-run growth rate of an economy is determined by its population growth rate and the rate of technological progress. Per capita income grows at the latter rate. Using this framework, a temporary destruction of a country's physical capital stock causes an immediate decline in the the capital-labor ratio to a point well below its long-run equilibrium level. This increased capital scarcity increases the productivity of capital and leads to higher productivity growth rates. Consequently, per capita income rises at above equilibrium growth rates and asymptotically approaches the long-run growth path. The growth rate itself is inversely related to the difference between the actual and the equilibrium capital-labor ratio. At the beginning of the reconstruction phase, growth rates are highest but gradually decline as the economy moves to its long-run growth path.
Based on this theory, there have been a great number of empirical studies, particularly in a cross-section context. The standard growth equation of these studies relates income growth to initial per capita income and several other determinants, including population growth, trade orientation, and investment rates in physical and human capital (Barro 1995). …