Anybody with even a shred of curiosity can conduct a simple scientific experiment. For example, all it takes to compare the boiling points of plain and saline water is to heat both on a fire and see which one boils first. Social scientists often complain that they are constrained in their work by the inability to conduct experiments of even high-school simplicity. Not always, though. Now and then comes the rare and wonderful opportunity to break free and observe a natural experiment.

Between 1950 and 1990, Germany–divided into two–was a laboratory for many such natural experiments to study the relative merits of capitalism and socialism. Bruce Kogut of the Wharton School and Udo Zander of the Stockholm School of Economics’ Institute of International Business used the laboratory to analyse the effects of the socialist system on innovation. In a paper titled, “Did Socialism Fail to Innovate? A Natural Experiment of the Two Zeiss Companies,” Kogut and Zander examine why the transition from socialism to capitalism, which began with wild optimism, has often led to great economic dislocation and human suffering.

The division of the German optics firm Carl Zeiss at the end of World War II created conditions suitable for a natural experimental design. This created two firms: Carl Zeiss Jena in the socialist German Democratic Republic (GDR) and Zeiss Oberkochen in the capitalist Federal Republic of Germany (FRG).

The authors compare the patent histories of the two firms from 1950 to 1990 to compare the technological achievements of two similar firms operating under different institutional arrangements. The experiment ended in 1990, with the takeover of parts of Zeiss Jena by Zeiss Oberkochen. The subsequent patent history of the remaining (and reorganized) part helps in evaluating the techonological capabilities of a socialist firm suddenly exposed to a capitalist economy.

The results of comparing patent histories indicate a high correlation in the technological achievements of the two firms, despite the fact that they operated in very different economic and political systems through four decades. The GDR firm was no technological laggard. In fact, the history of Zeiss Jena’s patenting confirms economist Joseph Schumpeter’s view that a large socialist firm can successfully innovate.

Schumpeter assumed too readily, however, that the interaction of socialist firms with central planners would be free of political interference. As the analysis of the two firms shows, he did not fully recognize the fact that markets promote specialisation. Eventually, the need to innovate by plan forced Zeiss Jena into unnecessary diversification. It was forced, by plan, to succeed in areas in which it knew it had already failed. In a sense, the economist F.A. Hayek makes the more important point: The socialist economic system could not generate the emergent order that spontaneously filters and grows ideas into radical innovations. That requires a market system.

Drawing from their study of Zeiss Jena, the authors say that “the best socialist firms in the high technology sectors did not lack technological capabilities, nor even clearly the managerial capabilities required for market competition.” The fact that Zeiss Jena’s technology was good is proved by the fact that the parts of the company that Zeiss Oberkochen did not acquire went through a public offering of its stock, and its shares were sold quickly.

Despite having strong technology, why did so many firms fail to see through the period of transition from socialism to capitalism? After the union of the two Germanies, a surge in exports from West to East Germany contributed to the virtual collapse of East German industrial production. As the authors argue, this catastrophe was not a result of the inefficiency of East German firms. Rather, it followed from the way the transition from socialism to capitalism was handled. The transition in Germany had its quirks. Firms were privatized fairly quickly, but state subsidies have been substantial. The decision to convert the eastern mark at an overvalued exchange rate led to high real wages in the east, despite lower labor productivity compared to West Germany.

Firms used to operating in one institutional system (socialism) were suddenly expected to compete in a radically different one (capitalism). In such a period of disequilibrium, say the authors, the market price mechanism can serve to eliminate potentially viable firms. So the neoliberal insistence that capitalism should be built by design in former socialist countries (and with the help of shock therapy) needs to be questioned. The alternative view, that change should be brought about through existing institutions (including socialist firms such as Zeiss Jena), deserves a more sympathetic hearing.

The disruption of economic and social life in East Germany after 1990 shows that capitalism cannot be built overnight. The transition from socialism to capitalism is likely to be painful and so must be managed gradually. That, eventually, is what the German natural experiment proves.