Towards a Self-Regulating Economy: Heinrich Pesch and the Changing American Economic System

This article was originally presented at the Third World Congress of Social Economics, Fresno, Calif., Aug. 16-20,1983.


America is witnessing the uninhibited use of power by well-organized groups striving for an excessive share of national income. The problem is not one of recent origin and writers of different political persuasions have decried the inability of society to come to grips with it. Much publicity has been given to the pervasive activities of political-action groups on behalf of special interests which, according to Norman Miller of the Wall Street Journal, threaten to become “legalized corruption.”‘ In a stagnant economy, the consequences of selfish behavior in the highly concentrated basic industries have been particularly harmful as evidenced by the disastrous decline of competitiveness and employment. The use of market power is not only diametrically opposed to the idea of justice, but it endangers the very foundations of a democratic society. Groups possessing power guided by a philosophy of individualism represent “one of the most threatening features of our whole situation,” wrote John M. Clark in 1944. He called for a balance between self-interest and community responsibility.’ In the past, public reactions to the irresponsible use of private power led to more government controls which eventually evolved into elements of coercion.

Can freedom and justice be preserved in the face of both unrestrained private power and growing government intervention? It was Heinrich Pesch who clearly saw the dangerous trend in modern economic society and who called for a free, self-regulating economy in which the freedom, dignity, and welfare of the individual would be preserved against encroachments of private power as well as government intrusion. His middle-road economic system seems timely today. Though relatively little known to the American public, Peschian ideas influenced papal encyclicals of this century and guided the thinking of leading Christian-Democratic statesmen of post-World War II Europe. The German Social Market Economy under Konrad Adenauer came close to implementing the Peschian system. Peschian ideas are relevant to American economic problems today, and, consequently, valuable lessons can be learned from the German experience.

The Peschian System: Reconciling Freedom and Equity

Central to the Peschian economic system is a social philosophy which views human nature in its entire dimension and considers the economy as an organic unity consisting of many private economic units. Such economic units, while working to promote their immediate interests, cooperate to fulfill the purposes of organized society. The goal of the economy, therefore, must be the satisfaction of the entire range of human needs of all the members of the national community. In general terms, the economic system should provide man not only with the bare material necessities of life, but also should contribute to conditions conducive to man’s fullest cultural, social, and spiritual development. Obviously, this is a larger goal than the one formulated in terms of the economic principle found in most conventional textbooks (“the greatest product with least inputs”). In the Peschian system, the primacy of the individual is asserted through an institutional anchoring of two mutually interdependent and reinforcing principles: solidarity and subsidiarity. Solidarity recognizes the fact of mutual interdependence of human beings and the need for cooperation to achieve common ends sought by all members of society. It presupposes a view of the common good that is deeply rooted in the Judeo-Christian tradition of the Western world, a view which is acceptable to most members of society. Rauscher explains solidarity as “the commitment of the individual to economic, social, political and cultural cooperation, to the joint realization of possibilities and the common sharing of burdens.” The principle of subsidiarity, on the other hand, which insists that intervention by government, when necessary, should be at the minimum level, prevents the misuse of power by government and induces lesser groups to govern themselves. The implication of the Peschian doctrine is that it is the primary responsibility of individuals and private groups to attain their material welfare and that their interaction should promote not only their immediate interests but also the common good of all. Government intervention in the economy is needed when any situation threatens the common good. Normally, in the Peschian view, it would be limited to policies that “stimulate, assist, coordinate, and regulate self-responsible private activity and decision.” Pesch rejects the classical notion that social justice would be achieved automatically if individuals operated with maximum freedom in response to market incentives. While most economic decisions are made by consumers and producers in response to free market prices, Pesch sees the possibility of competition degenerating into monopoly and, therefore, acknowledges the need for regulation. In essence, Peschian regulation to establish order in the market is implemented through the interaction of producers and consumers, organized private groups, and the state. Significant in the Peschian system is the role of organized groups. Their function has been often misunderstood, according to Oswald von Nell-Breuning. In his interpretation of Pesch, two types of vocational groups can be distinguished: one at the community level within whose competence are “all community tasks resulting from the nearness of habitation” or “the common spatial environment,” and the other, organizations of men who through their professional performance or social function are faced with a “common task.”‘ Both types of groups derive their rights from the principle of subsidiarity. In practice, this means collaborative action of community groups to resolve problems besetting communities, labor-management cooperation in industry, actions of professional and trade groups to further their interests, and a multiplicity of other activities of groups that play many legitimate functions in economic life, functions which at any given time cannot be performed by individuals alone but only by organized groups.

In short, Pesch agrees with Adam Smith that it is individual initiative and effort that creates material wealth. Unlike Smith, however, who stressed the importance of self-interest in achieving social benefits, Pesch also emphasizes the role of cooperative efforts of men in promoting the common welfare of society. It is interesting to note, in this connection, that while most of our conventional textbooks ignore the role of group activities in our economy, their function and synergistic impact upon the socio-economic well-being of society has been well understood in the two most successful market economies of recent years, in West Germany and Japan.

The Social Market Economy Vs.

The Social Welfare State

The experience of the German Social Market Economy demonstrates that a free-market system can be harmonized with demands for social justice. Moreover, it shows that the delicate balance between a free market, on one hand, and social justice, on the other, can be preserved only if all private groups participating in the economic process are imbued with a concern for the common welfare and not motivated by selfish interests alone. This balance between the market and the social system was shattered after 1969, mainly as a result of slower growth and political events. The explosion of demands for ever broader social-welfare benefits gradually transformed the Social Market Economy into a social-welfare state. The dependence of the individual on the paternalistic state has dramatically increased. Concerns which until now were the responsibilities of private associations or communities were increasingly shifted to the public sector. Freedom and personal responsibility diminished. The efficiency of the market economy suffered. But before we discuss the differences between the Social Market Economy founded on the principles proposed by Pesch and a social-welfare state, let us first briefly sketch the working of the German Social Market Economy as it functioned between 1948 and the late 1960’s.

The founders of the Social Market Economy were faced with reconstruction problems of staggering proportions. They rejected recommendations for planning and direct controls aimed at gradual transition to a peace-time economy since this approach would have led to totalitarianism. They also opposed an unregulated market economy with its ideal of laissez faire. While a competitive market was considered as an indispensable instrument of social organization in the new economy, it did not imply an economy altogether free from government intervention. As Muller- Armack expressed it, the new order presupposed a free-market economy, but was not identical with it. The government was expected to conduct a comprehensive economic and social policy which would complement the market. Perhaps the single most striking characteristic of the new order was the insistence that economic and social policy measures conform with the market and not distort or weaken the effectiveness of market forces.’ Thus, inequalities of income were moderated by means of a progressive income tax which, however, was mild enough not to interfere with market incentives. Anti-cyclical stabilization measures relied heavily on “built-in stabilizers” to minimize intervention in the economy, though measures encouraging full-employment levels of aggregate demand were not entirely rejected. One should note here that in contrast to this approach used in Germany, in other “mixed” economies social-policy measures often led to reduction of competition and elimination of market incentives.

While the success of the German economy was attributed to many factors, the reliance on free markets undoubtedly played a crucial role in moving the system closer to self-regulation. The free but ordered competition was supposed to ensure that the economic functions of the price mechanism were carried out without monopolistic impediments to the natural process. “Ordered” competition implied that prices reflected true costs. The German Anti Trust law of 1957 was aimed at maintaining a healthy competitive structure, though questions remained as to the effectiveness of the new anti-trust policy which collided with the strong tradition of legalized industrial cartels. Though the system was not flawless, it was credited with promoting justice by making economic rewards dependent on personal accomplishments and by curbing incomes traceable to market power. The state played its role by enforcing the competitive order, by protecting the common welfare from selfish group actions, and by establishing a floor of personal welfare through a comprehensive social security system. At the most basic level, the government provided for sound currency which stabilized purchasing power and, with confidence in the currency restored, revived consumer saving.

In discussing the achievements of the German post-war economy, credit must be given also to the exemplary behavior of private groups. Although numerous organized groups, like trade and professional associations, trade unions, and employers’ groups, were actively engaged in promoting their own interests, in most cases a willingness to subordinate group interests to the demands of the common good was readily noticed.”‘ Within this framework set by a free economy and government policy, the individual has had both the opportunity and responsibility to improve his condition by his own choice and efforts.

Is the experience of the Social Market Economy relevant to the American economy? The widespread use of market incentives to achieve public purposes demonstrates that the market process can become an instrument of social policy. It is well known that government intervention in the activities of businessmen and consumers is inherently difficult. It is more efficient to encourage people through the use of market-like incentives to do certain desirable things than to rely on government intervention to achieve the same objectives. Moreover, to the extent that market incentives are used, the need for government intervention, which often includes elements of coercion, is reduced. Incentives played a crucial role in restoring the viability and efficiency of the German economy. Market incentives were used widely in such areas as industrial safety, employment of the handicapped, pollution control, energy conservation, and many others. There is a need to learn more about the working and the effectiveness of market incentives. Best known is the application of incentive taxation. Low marginal tax rates were used in Germany to stimulate effort. The tax structure relied heavily on turnover and sales taxes to avoid disincentives and to stimulate saving and investment.

In the American economy, the use of market incentives has been emphasized only recently and their application is still limited. As Charles Schultze stated in 1976, “With some exceptions, modifying the incentives of the private market to achieve public purposes is not considered a relevant alternative.”” In the United States, the proliferation of new regulations in the 70s has created a wave of resentment against excessive bureaucratic control and has exacerbated the problems of many industries.

The Peschian system, in order to succeed, requires a “Weltanschauung” or spirit. The spirit is the desire for the common good. The debate in Germany over the objectives of the new social economy produced an extraordinary degree of support from most segments of society, and the debate itself was instrumental in developing the supportive spirit. To be sure, the development of public support for the new economy was influenced also by historical factors unique to post-war Germany. Concern for the public welfare was reflected in improved labor- management relations. Opposition to class warfare and the antagonistic labor-capital climate soon led to the strengthening of employee participation in the decision-making process in areas affecting the interests of workers. The new cooperative spirit was institutionalized in the Work Council Law of 1952. Employee participation at the grass-roots level, and later co-determination, have contributed to industrial peace and worker identification with society. In the same spirit, German business did not remain insensitive to the demands of the common good. Involvement of business firms at the community level was widespread. Social objectives were incorporated into the plans of many corporations. Social audits, new designs in board structures, and other social innovations were successfully introduced by major firms.” Though it was acknowledged that not all problems of accountability can be solved without impairing productivity, real progress towards social responsibility was achieved.

What conclusions can be drawn from the experience of the German Social Market Economy? The founders thought of it as an ethical order. Clearly, reconciling a free- market economy with the demands of social justice requires an institutional framework which can restrain the extremes of both private power and government intervention Moreover, cooperating private groups, guided not only by self-interest but also by concern for the common interest, complement the free – market system. The state plays the part assigned to it by the principle of subsidiarity. To a large extent, this self-regulatory framework was present in the early stages of the German experiment.

But the agenda was not completed and problems emerged. The system of incentives designed to stimulate rapid growth in the hope that economic expansion will in the process help to raise the standard of living of everyone came under increasing attack by those who insisted on a more equal distribution of income. The cooperative spirit of the post-war years gave way to a growing polarization of society. Conflicting philosophies increasingly influenced labor-management relations. Earlier workers’ participation in enterprises was based on the Peschian view of society emphasizing “bottom-up” cooperation between labor and management in all matters that affect the interests of workers. The 1976 extension of co-determination reflected the syndicalist trade-union view of “top-down” co-determination. The new approach, many feared, has destroyed the existing balance of power and the cooperative atmosphere that had prevailed before.

The events of the late 60s brought about an escalation of demands for greater involvement of the central government. Entitlements expanded rapidly and public budgets had to assume burdens which until now were in the domain of private responsibility. Tax burdens increased sharply and undermined the efficiency of the market economy. The principle of subsidiarity gradually eroded as more functions were transferred to the state. Group individualism began to raise its ugly head. Characteristic of the changed attitudes were the demands put forward by radical students that society should pay them a salary for their willingness to study.” The common interest of groups eventually gave rise to interest groups which attempted to enforce their demands by the weight of their power. The spirit of solidarity was destroyed. The transition to a paternalistic social-welfare state was accomplished.

The Peschian Model And

The Changing American Economy

Could the Peschian model of a self-regulating economy affect American economic life? The tradition of individualism is strong in the American economy. It manifests itself in organized efforts aiming at economic and political power. “Marginal morality” is strongly entrenched.” Too often, the position of the individual is threatened by actions of the powerful. But the American system is still evolving and new trends are emerging, trends which offer opportunities for moving the economy closer to the self-regulating model envisioned by Pesch. Let me suggest three such changes which, I believe, are taking place and which, in time, may move the American economic system closer to the ideal proposed by Pesch:

1. There is a trend toward a more efficient market economy. Deregulation contributes to a shift from cartel-like structures in major industries to competitive conditions. It opens new areas to private initiative, diffuses economic power, and contributes to more widespread ownership of productive property. Since there is now a broad bipartisan consensus that deregulation is desirable, the trend is likely to continue. The trend toward a more competitive economy is nourished by the rapid growth rate of new business ventures. Nearly 70% of new jobs come from firms with 20 or fewer employees, 4 years old or less. The Fortune 500 have experienced virtually no net job growth for more than a decade.” Though small firms are highly unstable, they contribute most by creating new ideas and providing the engine of growth. But in order to have a just economic system, Pesch suggests, competition ought to be complemented by cooperation of private groups as an integral part of an efficient and free economy.

2. There is increasing cooperation and a growing partnership atmosphere between labor and management, as evidenced by the lengthening list of companies and unions that are moving away from the adversarial relationship and that are involved in joint efforts to make jobs more efficient and meaningful by enhancing the role of human resources. Not only is collective bargaining assuming new forms. Profit sharing plans have grown dramatically in the United States over the last decade, as reported by the International Labor Organization. There are over 250,000 deferred profit-sharing plans covering 15 million workers and involving $50 billion.

In addition, strained economic conditions and ideas from Japanese and European industries are forcing the bargaining parties to rethink the assumptions underlying the adversary principle. In many corporations there is a change in the management style from a hierarchical type of decision-making to a participation process starting at the lowest level. One of the largest unions, the UAW, an institution built on confrontation, has charted a course intended to involve workers in decision-making. The new role clearly will not happen overnight, but a break with the traditional American labor-management conflict has begun. As one UAW official concedes, “we have been teaching our local leaders and our members all these years to be aggressive and militant toward the companies. Now, we have to turn around and undo all that.” No doubt, a new chapter in American labor-management relations is beginning.

3. Private associations and community groups are proliferating all over the country. Their contributions to the socio-economic well-being are well-known, though cannot be quantified. Who can deny their role in enhancing human life and their contribution to the spirit of community? Involvement of individuals in groups provides opportunity for creativity, and promotes self-expression and self-reliance. Increasingly, groups acting in the public interest seek a voice in government decisions affecting community welfare and policy makers must be aware of public input. Marketing scholars tell us that a preference for living in small communities is emerging that will revitalize local governments and will have profound economic implications. In short, all indications are, the principle of subsidiarity is gaining in its creative function.

Moreover, there are other changes. While individualism is still prevalent in America, it is no longer the dominant factor in our society. Changed social values and higher educational levels of our younger labor force make our economic system prone to reform. Many businessmen accept their obligations towards their community, their workers and customers. Clearly, a different social and economic environment is evolving. The time has come to imbue our economic system with a new spirit. Given the changing climate of the day, the Peschian “middle way” may find broad support on the basis of its intrinsic merit. It should be acceptable to many who are groping for new approaches to our economic problems.


Stanley Zemelka was a professor of Economics at Bellarmine College.

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