Schmoller on law and his economic theory
The mainstream opinion about Schmoller and the Historical school can be summarized as follows (see Fischer, 1968; but compare the more receptive accounts in Journal of International and Theoretical Economics, 1988, pp.
524ff.; Bock et al., 1989; Schiera and Tenbruck, 1989; Backhaus, 1993; Giouras, 1994): he proposed a historical-realist, psychological-ethical, inductive-descriptive programme which should include law, morals and culture. The research programme was more historical than economic and some blame him for having delayed scientific progress in economic theory (and not only in Germany). He has even been held responsible for the inflation of 1923 (Barkai, 1991) by neglecting simple quantity theoretical connections and so influencing the economists of his time and long after. According to this view, his theory was neither coherent and worth consideration nor an alternative to neoclassical mainstream thinking.Schmoller’s weakest point was his methodology (a subject he was not really interested in), which became apparent in the so-called ‘first debate about method’ (‘der erste Methodenstreit’) between him and the Austrian, Menger. Schmoller’s 20-page review (1883) of Menger’s Investigations (1883) and Dilthey’s book about method (1883) was the start of a series of (self-) misunderstandings on both sides. Menger could not solve the problem of distinction between empirical and exact laws, between explaining and understanding, a representational versus a constructivist approach which showed up in Schmoller’s work as the problem of induction versus deduction (compare Schmoller, 1949, 1900, ch. II. 4, and Menger, 1884). Both in principle asked the same questions and both failed (see Peukert, 1997, chs 3 and 4).
The point here is that Schmoller cannot be linked to one methodological camp. At the same time he held the succession model (first induction, then deduction), the division of labour model (induction and deduction as complementary activitites), the imperialist model (induction is better than deduction) and the pragmatist model (deduction is bad because it leads to Manchester atomism).
For Schmoller, on the one hand, classification develops by itself and according to empirical findings; on the other hand, all thinking is abstraction and all mature science is deductive. Theoretical elements of David Hume, Immanuel Kant, John Locke and others can be detected in his reflections. The antinomies between a natural science and a philosophical-sociological, a psychical and a physical-organical approach, the freedom of will versus necessity, and the ethical individual motivation versus the determination of action by the environment stand out and none of these tensions is ever resolved. It may be mentioned here that all his major findings were already apparent before he discovered the social problem and before he had undertaken any historical or empirical studies (see Schmoller 1860, 1864/65).In one sentence only (1883, p. 247), Schmoller raises the fundamental substantive question: what holds (capitalist) economies together and directs their development - exchange, value, money and so on (Menger’s quasiAristotelian basic categories) or interdependent social organs, institutions and rules?
Schmoller’s institutional theory is not easy to summarize because in his exposition a critique of the classical economists, educational elements for civil servants, his social policy views and a positive theory intermingle and cannot be described by some fundamental hypotheses; another reason may be his use of the German language (only a few pages of his Grundriss have been translated into English).
The starting point in Grundriss (1900/1904) is not a utility-maximizing individual and an abstract concept of exchange, but the fact that economic life is embedded in political and social structures. They are a manifestation of the socialization of law, custom, morals and religion. Historically, the main trend lies in the enlargement of the resulting socioeconomic organizations and institutions, from tribes in hunter and gatherer societies to little kingdoms during medieval times, right up to the European Union (EU).
The intentions, problems and irritations, and the specific combination of economic, political and cultural factors that affect the introduction of the single European currency can be seen as a nice example of Schmoller’s organic theory of institutional evolution as a precondition to more or less efficient markets.Although the aim of economic action is the increase in commodities and wealth, the great miracle of the economy is the productivity-enhancing quality of cooperation and coordination. One precondition is what Schmoller calls the accumulation of symbolic capital (like language, writing and education), which socializes the individual and makes him or her able to cooperate and share the perspective of others (Adam Smith’s impartial spectator). Anthropologically, man is driven by down-to-earth material pleasure and pain and the drive of survival and rivalry, but also by the drive of social approval (one of his socially integrating appetites). Schmoller holds a homo duplex view of the human condition (individualizing and socializing tendencies, in contrast to the one-sided homo homini lupus preconceptions of, for example, game theory). The state has to set the limits for individual action, in whose compounds bilateral and multilateral negotiational compromise organs are at work to make cooperation a success.
In the social cooperation game, the guarantee and protection of individual property rights is the core of the law, but the more complicated and interdependent economies become for reasons of density and sheer numbers (and, we might add, the increase in external effects of different kinds) the more legal, negotiational and state institutions have to increase their regulating potential. To put it into the paradox formulation of Commons, they have to organize ‘collective action in control, liberation and expansion of individual action’ (1950, p. 21). Schmoller’s view therefore was that there exist beneficial, necessary and complementary positive feedbacks of individualizing and socializing tendencies in modern economies.
The necessary tension and duality of economic life and its institutions can be found not only on a macro level but also on the micro level of all private organizations and institutions, such as insurance companies, where two forces are at work: a purely private law and an egoistical tendency. But there is a human public side too, operating in the interest of the common weal. The businessman concentrates on the first aspect, the social politician on the second. To find a compromise between the two tendencies (which are not identical according to a naive and simplified invisible hand understanding) is the art of economic and political action.Does Schmoller (1904, bk 3, pt 4, concerning value and prices) have a specific concept of markets, equilibrium, competition and so on - the core questions of present-day economics? Most economists doubt it (for an opposite view, see Priddat, 1995; Peukert, 1997; and to a certain degree Schumpeter, 1926). For Schmoller, a given price is taken as the starting point (which has some inertia because the economic agents prefer a certain predictability in an uncertain world). Supply and demand exert some pressure on it. But for Schmoller, first, ‘supply and demand’ are only abstractions for more important underlying forces. Second, they are not evident but have to be detected by economic agents (depending on institutional factors like information services and legal obligations to inform the public, as in the case of joint-stock companies). Third, prices must be interpreted (the question whether prices go up or down in the future is more important than the recent price as such).
In real markets in time and space without abstract auctioneers and costless full information, actors with restricted knowledge enter the stage, although they have a certain opinion about the price ranges. They first orient themselves to get a clearer picture and they may correct their hypotheses in a quasi-hermeneutical speech situation (questioning, arguing, evaluating).
For Schmoller, the market process is active haggling and bargaining, depending on the prevailing thought maps which themselves influence the ‘fundamentals’. For him the typical market scheme situation is the bilateral monopoly as the ideal-type or standard case, like the supply and the demand sides, entrepreneurs and employees: a certain number of actors on two sides of market transactions, foreshadowing modern transaction cost analysis, according to which, as a result of asset specifity and lock-in effects, most market transactions lead to a fundamental transformation. ‘Joined as they are in a condition of bilateral monopoly, both buyer and seller are strategically situated to bargain over the disposition of any incremental gain whenever a proposal to adapt is made by the other party’ (Williamson, 1985, p. 63). Schmoller realized that the times of small business and competitive markets in the strict sense belonged to the past. He thought about economics when, after the German Reich’s unification in 1871, his country was in full transformation towards a mass production economy (unfortunately, he saw cartels in a much too rosy light, as if they were economic institutions to smooth out conflicts and price volatility, although he was not an unrestricted proponent of them).Schmoller points out that actors on micro and macro levels have different competencies and autonomy, depending on the legal framework defining non-neutral rules of the game (for example, to withhold basic services and goods for the other market side), business relations, knowledge, motivation, negotiational abilities, education, market power, stockpiles, financial reserves and transaction urgency, which means ‘the abilities of the parties to take and to inflict losses during stalemates... Toughness in the sense of unwillingness to yield in a range in which the other party is expected to yield if one fails to do so’ (Fellner, 1949, pp. 27-8). These are some of the manifold forces and influences which are summarized as ‘supply and demand conditions’, some of which cannot be expressed as numbers and equations.
Although Schmoller did not welcome or even grasp the results of more formal reasoning in his time (that of Joseph Bertrand and Francis Y. Edgeworth) he very well understood that in oligopolies and bilateral monopolies a formal derivation of the equilibrium (price) is usually not possible (Stigler, 1966). It is not passive adaptations to given market prices and the anonymous mechanical market mechanisms that take place, but strategies economic players play, which lead to Bowley, Stackelberg and other solutions. They are the essence of competition depending on the parties’ relative power positions in the sense characterized above. Nor can distribution be determined by strict formal-mechanical reasoning, and the strategies the players choose cannot be derived in a straightforward way by adding up the structural factors of the bargaining situation mentioned above. This is the substantive reason for Schmoller advocating a more historical method rather than abstract models. A historical method that takes into consideration a wide range of cultural and societal factors in their ever-specific interrelatedness in real markets needs a hermeneutical-intuitive approach more than the counting of numbers, and is able to consider the widely indeterminate choice of strategies and results. In bilateral monopolies, abstract reasoning is of little help to determine prices and equilibria.
The strategies in oligopolistic and bilateral monopoly situations can be broken down into the strategies of mutual quantity adaptations or the strategy of a monopolist and the other market side as quantity adapting, or one side is fixing options (setting price and quantity) and the other side is accepting options. Only for the extreme and somewhat unreal cases of mutual quantity adaptation and clear-cut option fixing does an equilibrium exist. Besides the non-determinate and instability arguments, the social question arises because in Schmoller’s time the entrepreneurs set the prices and the workers determined their supply. Owing to the oversupply of the workforce, with no legal restrictions (a 15-hour working day), no insurance against unemployment (high transaction urgency), no public education (knowledge as a power source) and so on, the capitalist camp could more or less play the role of option fixing, that is realizing the exploitation point. As Schmoller argued, against Lujo Brentano and others, even in the case of a formal freedom of coalitions (trade unions were disadvantaged in their ability to organize labour), the capitalists were still able to realize the exploitation point. Even the more recent literature (Scherer, 1979, ch. 8; Tirole, 1988, chs 5 and 6) concludes that, in reality, in bilateral or oligopolisic market situations an unstable equilibrium or a situation without equilibrium will result, which led Stackelberg (1992) in the 1930s to the conclusion that only a strong quasi-dictatorial state (realized in Germany after 1933) could bring the anarchy of factional disputes to an end. Schmoller supported a more democratic solution: the state should set minimum rules (working hours legislation, education for all and so on) and fostered institutions like works councils (Betriebsrate) to bring both market sides to the round table. Instead of anonymous market processes, consensual and negotiational solutions should be sought. The logic of the market should be complemented by a sociologic of institutional compromise.
The result for Schmoller was that, to make capitalism function, markets must be regulated. The stability of market processes depends essentially on non-market interventions. In bilateral monopolies (and all continuing transactions tend to this ideal type) law plays a major role in taming the disintegrating forces and in strengthening the weaker side for the common good of productivity, thus enhancing social cooperation and social peace and trust.
This positive law of contract is combined today with innumerable business customs, with just as many statutes and business arrangements, which include its activities. All this links up with penal and administrative law, the trade, agricultural and building law, the right of domicile, the multitude of regional and local police regulations, the by-laws of decentralized public corporations, and the constitutions of societies. All this together constitutes the dense system of social harmonization and standardization of the economic process and of all transactions. It is a system of norms, dams, guiding rules, orders and prohibitions, which regulate the stream of economic life, in defining this or that in agreements as being an offence or without legal force... Immoral contracts, contracts which are considered in general harmful, e.g. today hereditary employment contracts or contracts for a very long period without the right of notice, the pay of factory labour in commodities instead of cash are always forbidden or punishable. It is always the last tendency of this order to allow by customs and law a certain free exertion of the free individual will, but also to protect the common interest and the weaker, to hinder the spread of immoral activities. (Schmoller, 1904, pp. 17-18)
Economic policy along Schmollerian lines in Europe today (tax evasion by multinationals, high unemployment rates, real wage decline and so on) would not consist of decapitating political institutions and governments by surrendering their margin of autonomy in fiscal, monetary and social policy matters to the dictum of a central bank. First, and above all, the relevant policy institutions should at least catch up with the globalization of production and investment on the political plane. The level of the extension of economic activity in Schmoller’s time was the national one, so he supported the national state as the relevant political centre to balance powers (collect taxes, institute rules against child labour, strengthen the weak side, introduce measures and weights, and so on). The same process of the enlargement of economic interdependency is occurring now on an international scale and even at the EU level (the developing former socialist countries notwithstanding) the challenge of globalization seen through the eyes of Schmoller hardly seems to have been understood.
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