Carnegie Bosch Institute 
Did Socialism Fail To Innovate? 
A Natural Experiment of the Two Zeiss Companies 
 
Bruce Kogut
Professor, Wharton School, University of Pennsylvania, Philadelphia, PA 19104-6370, 
Tel: 215-8981093, Fax: 215-8980401, e-mail: kogut@wharton.upenn.edu

and 

Udo Zander
Associate Professor, Institute of International Business, Stockholm School of Economics, Box 6501, S-113 83 Stockholm, Sweden, Tel: +46 8 7369513, Fax: +46 8 319927, 
e-mail: iibuz@hhs.se

December, 1997 

We would like to thank Bruce McKern and the Carnegie Bosch Institute for their support, Frau Edith Hellmuth of the archives of Zeiss Jena for her assistance, and Jeff Fear for comments. Additional funding has been provided by the Reginald H. Jones Center and the Institute of International Business at the Stockholm School of Economics.   

Abstract 

Did socialism collapse due to the failure to innovate? Schumpeter had hypothesized that capitalism would evolve into socialism as large bureaucratic firms came to dominate technological innovation. Hayek proposed that this focus on the large firm failed to recognize that the engine of capitalism is the competitive process of discovery in the market. The case of Carl Zeiss provides a natural experiment to analyze these two views. By an analysis of patent records from 1950 to 1990, we trace the technological efforts of Zeiss Oberkochen in the FRG and Zeiss Jena in the GDR. The analysis shows that Zeiss Jena gradually developed considerable technological competence, but the deficiency of the innovative potential of the socialist system led to political pressures on key firms to innovate by plan. These pressures dissipated their scarce technological capabilities. 

Keywords: institutional environments, firm capabilities, innovation 

This paper has two aims. The first is to suggest that firms under socialism did not stagnate, but operated in reference to the incentives of their environments. In this regard, they accumulated capabilities to innovate and produce in response to their environmental signals. The pressures of the institutional environment was an important factor in determining the development of technological capabilities of the East German firm (Meyer and Scott, 1983). The focus in the literature on transition on the inefficiency of socialist firms frames the question wrongly. The critical issue in analyzing their potential to adapt to capitalist markets is whether these firms developed the requisite innovative capabilities under socialism. 

The second aim is to provide a window on the causes of the German policy debacle in their efforts to revive the East. The initial assessment in 1990 by the Treuhand of the state of East German companies gave the estimate that only 30 % of the firms were clearly salvageable. This estimate gives the misleading implication that East German industry had been under inefficient incentives to develop economically viable enterprises. A more appropriate inquiry for an analysis of the transformation is whether the East German industry had the potential for self-renewal in the newly prevailing conditions. One might as well ask how much of American industry would initially survive a macro shock that not only radically reversed relative prices, but also was accompanied by the loss of export markets and the collapse of internal demand. 

These issues lie at the heart of the debate on gradualism. Policies of shock therapy require the immediate abolishment of price controls, the elimination of state subsidies, and the privatization of state-owned firms. These policies are motivated by the belief that private ownership places managers under incentives to be more efficient by removing ("depoliticizing") state interference in enterprise decisions (Shleifer and Vishny, 1994). 

An alternative policy relies upon a gradual dwindling of the state, with successive though discrete waves of privatization. Peter Murrell (1992) and David Stark (1996) provide complementary interpretations of the benefits of gradualism as arising out of an evolutionary perspective. In this view, firms in transition countries are in crisis not due to a lack of incentives, but to their deficiencies in their cumulative capability to compete in capitalistic markets. Firms are repositories of knowledge, by which it is meant that they operate by a body of routines and organizing principles that are only imperfectly understood and open to facile manipulation. The resistance of firms to change is not due to faulty incentives, but rather to the difficulty of firms to reconstitute their ways of doing things. In a period of disequilibrium, the market price mechanism can serve to eliminate potentially viable firms. Gradualist policies provide the opportunity for firms to adapt to the new conditions by an evolutionary transformation, but the initial institutions have persisting effects. 

The debate between shock therapy and gradualist schools is implicitly anchored on different emphases placed on incentives or organizational capabilities. Policies of shock therapy tend to treat the transition problem as creating appropriate market incentives by which interested owners choose motivated managers to implement best policies. Gradualists concede the importance of external incentives, but argue that the evolved capabilities do not readily change in response to radical environmental shocks. 

The gradualist argument has a complex parallel in the debate between Schumpeter and Hayek regarding the viability of socialism to innovate. Schumpeter (1942) predicted that the socialist firm would be able to innovate as well as the bureaucratic capitalist firm that had come to dominate R&D programs in capitalism. As Hayek (1988) subsequently came to articulate, the appropriate comparison was not that between socialist and capitalist firms, as that between planned innovation and the emergent properties of market competition. The remedy offered by shock therapy is, oddly, not distant from the belief that market socialism could succeed, if only the incentives could be gotten right. Oddly, it is the argument of Hayek that implies that a system of economic planning encouraged a specialization at the firm level to compensate for absence of an emergent order associated with markets. 

This paper exploits an unusual natural experiment to analyze this issue. The optical firm, Zeiss, was split into two independent companies after World War II, one located in Oberkochen, West Germany, the other in Jena, East Germany. By a comparison of their patent histories from 1950 to 1990, this paper analyzes the cumulative technological innovations of the two companies and their efforts to diversify into new technical fields. 

The results indicate a high correlation in the technological achievements of both countries. Using a measure developed by Jaffee (1986) for technological relatedness, we analyzed the degree of overlap in the technological output of the two Zeiss companies. Despite significant technological diversification, their patent activities remained highly correlated throughout the post-war period. Even if Zeiss Jena benefited by observation of its western counterpart, it retained an important capability to absorb and exploit technological knowledge. 

German policy in the East did not follow the principles of shock therapy, except for the radical imposition of price decontrols. Firms were privatized fairly quickly, but state subsidies to firms and, more directly, workers have been substantial. The policy to convert the eastern mark at an overvalued exchange rate, and the subsequent fixing of east German wages relative to the west German wages at a level not justified by productivity differences, have discouraged investment. However, because these policies nevertheless constituted a "shock," the findings on the innovative capability of Zeiss Jena carry the important implication that viable firms can fail in the initial period of transition. The emphasis on faulty managerial incentives as the disease that is cured by market reforms needs to be better balanced by an understanding of the competence of the socialist firm and the inordinate difficulty of radical change under conditions of brutal shocks to the macro-economic system. 

I. Background 

Disagreement with the Soviet Union over the reunification of the occupation zones led the United States, Britain, and France to consolidate their zones in 1949 into the Federal Republic of Germany (West Germany). Under Soviet auspices, the German Democratic Republic (GDR) was officially formed from the Soviet occupation zone in that same year with a communist government. East Germany became a one-party state with nationalized industries and collectivized agriculture. 

A mass exodus of 3.5 million people between 1945 and 1961 severely damaged the East German economy. Konrad Adenauer, West Germany's chancellor and foreign minister in 1949-63, was committed to the reunification of Germany and refused to acknowledge the legal existence of the East German republic. In 1961 the Soviets authorized the building of the Berlin Wall, separating the eastern and western sectors of that city and cutting off the only remaining escape route to West Germany. 

The building of the Berlin Wall marked the beginning of an economic revival for East Germany. In the early 1960s and again in 1968, new economic reforms loosened the control of central planning and encouraged investments in technology. GDP growth levels in the 1960s were impressive, but heavy industry and energy production were a priority over consumer goods. The drift toward market socialism was halted in 1970 following severe bottlenecks in production. As a consequence of policies introduced in 1971, the GDR had one of the highest levels of state ownership and industrial concentration of firms. About 95% of industry and agriculture were state-owned or cooperatively held. Increasingly, firms were organized into large holding structures, called Kombinate, with the intent to decentralize some central planning to these intermediate units. 

These policies did not work. Labor productivity declined to about 50% of that in West Germany; the high level of female participation (84%) partly compensated for the lower productivity. Still, GDR citizens enjoyed the highest standard of living in the Eastern Bloc in terms of car density (209 per 1,000 inhabitants), housing standards, and urbanization level. In terms of GDP per capita, the GDR could be compared to Spain, Portugal, Greece, and Ireland. However, the official statistics hid the vast problems in quality and weak infrastructure. Despite falling productivity and investment, the government sought to maintain consumption levels by foreign borrowing; disposable income grew faster than national output in the 1980s. By 1990, the economy was seriously impaired by shortages in investment goods and by collapse of demand in the East. 

With reunification of the two Germanys in the Fall of 1990, state-owned property was transferred to the Treuhand, a government agency entrusted with the privatization or liquidation of the existing firms. By 1995, the Treuhand had privatized 13,800 firms, completed its task, and was dissolved. In 1991, Zeiss of Oberkochen purchased ownership of Zeiss of Jena. The considerable assets that were excluded in the sale were organized into a company called Jenoptik. 

II. The Natural Experiment 

An experimental design seeks to measure the effects on a dependent variable (or outcome) under study by varying an experimental condition, i.e. treatment. The presence of other potential influences is eliminated in a controlled setting using a random sample. Outside the laboratory, these controls are applied by measuring their contribution to changes in the dependent variable in order to isolate the influence of the treatment condition; the samples are often not random. A natural experiment is a design that, though also using non-random samples, is able to isolate the effects of the treatment variable by eliminating the effects of extraneous factors. 

The division of Carl Zeiss into two firms at the end of World War II created conditions suited to a natural experimental design. At the end of the war, US forces evacuated the board of management of the Zeiss firm (located in Russian-occupied Germany) and about 100 scientists and technicians of the Carl Zeiss firm (Jena) to West Germany. Shortly before that, the Jena factory had been largely destroyed. Both Zeiss Oberkochen and Zeiss Jena started their operations basically without physical assets. The machines left in Jena were deported to the Soviet Union as war indemnity during the 1940s. 

For our purposes, we identify the patents of the two firms as the experimental outcomes that measure the technological output of the two firms for the period of 1950 to 1990. The treatment is the imposition of a socialist planned economy in the East; Oberkochen is used as the experimental control. The research design thus involves the comparison of the stock and development of technological skills in German firms divided in a West German and an East German branch after World War II until their reunification in 1991. 

Historical Background: 

The Pre-World-War II Period 

Jena was the primary location and the headquarters of Zeiss prior to the war. A workshop was founded in 1846 for assembling and selling of microscopes from other producers. Carl Zeiss (later in cooperation with his first apprentice August Löber) led the firm through an initial period of growth marked by new product innovations. Zeiss applied rigorous control of product quality and incorporated scientific methods and rational manufacturing methods. Realizing that improvements in optical instruments depended on advances in optical theory, Carl Zeiss started one of the earliest organized R&D units when he engaged the physics and mathematics lecturer at the University of Jena Ernst Abbe. Abbe started working for Carl Zeiss in 1866 and became Zeiss' business partner in 1875. 

During the 1860s, the locally based chemist Otto Schott also joined the firm. Abbe developed optical laws to their limits and improved the design of Zeiss microscopes, while Schott improved German production of glass for the lenses. Zeiss and the Prussian State financed a research laboratory for developing properties and manufacture of special glass (the "Glastechnisches Laboratorium") in 1884. By the time that the Schott Glassworks were established in the mid-1880s, Zeiss shipped its 10,000th microscope. Schott Glassworks retained a dominant position world wide in the production of borosilicate glass up to the 1930s. Through its close relationship with Schott Glassworks and the internal capabilities provided by Abbe's research, Jena exploited the possibilities for standardization and increased production of microscopes. 

In the following years, a range of product and process innovations in the areas of microscope and glass production turned the firm into a leading large-scale manufacturer that started to compete successfully in the UK, US, Austro-Hungarian, and Russian markets. Foreign direct investment was also undertaken with the establishment of production in Vienna (1906), Györ, Hungary (1908), Riga, and London (1909). In the late 1800s, the firm diversified its activities into optical measuring instruments, cameras, binoculars, telescopes, and planetariums. The products of Carl Zeiss Jena could be divided into four categories: microscopes, photographic instruments (lenses and object glasses), telescopes, and measuring instruments (Hagen, 1996). 

After Carl Zeiss' death, Ernst Abbe and Carl's son Roderich in 1889 donated the Zeiss firm and their shares in the glassworks to the Carl Zeiss Foundation (Carl-Zeiss-Stiftung, 1985, Schomerus, 1940, Abbe, 1896). Focus was placed on building up professional purchasing and marketing organizations, but the concern for workers' conditions was also manifested in the establishment of a welfare system sponsored by the firm. The foundation statute guaranteed workers personal rights and ignored their origin, religion, and political views in career decisions. Workers could choose their own representation, received a fixed minimum income, eight-hour work-days, paid holidays, sickness benefits, profit sharing, disablement and pension benefits (Carl-Zeiss-Stiftung, 1985). At Schott's death in 1919, his shares in the glassworks were added to the foundation. In 1894, Zeiss and Schott successfully exhibited microscopes, photo lenses, and thermometers at the World Exhibition in Chicago (Carl-Zeiss-Stiftung, 1985). 

International sales kept increasing. At the breakout of World War I, Zeiss which then had 9,000 employees, sold some 2/3 of production in foreign countries. After World War I, Zeiss engaged in radical improvements of manufacturing inspired above all by the American system of mass production using an assembly line. European exports during the 1920s experienced a shift from England to the Soviet Union, and exports to South Africa and Australia increased dramatically. Overall export sales were still around 65%. In the wave of concentration of the optical industry, Zeiss turned its eyes to the domestic markets and from 1927-29 acquired suppliers and competitors to created a true conglomerate (Schumann, 1962). The efforts in the area of R&D were continued, and by 1945 some 16 separate research laboratories were operating in Jena. During the war, the percentage of Zeiss Jena turnover used for military purposes rose to 75-80%. In 1930, the corresponding figure was 23% (Schumann, 1962, p. 510). 

Subsequent to the expropriation of the Jena enterprises of the Carl Zeiss Foundation in 1948, separate enterprises existed in Oberkochen and Jena. (The Schott Glassworks underwent a similar division.) They instituted legal proceedings internationally to settle who was entitled to use various names and trademarks and could call itself the "Carl-Zeiss-Stiftung," and in 1949, a new foundation was set up in Heidenheim, West Germany (Carl-Zeiss-Stiftung, 1985). In 1971, the world market was divided into different areas regarding the right to employ specific names and trademarks. 

The West-German Operations in Oberkochen 

The Oberkochen operation of Carl Zeiss commenced from scratch in 1946 by some 85 Zeiss-managers, engineers, and designers deported from Jena by the US occupation forces to Heidenheim in Baden-Württemberg (Carl-Zeiss-Stiftung, 1985). The managers were promised that their archives, technical documentation, patent records, as well as their laboratory equipment would accompany them, but none of this material ever reached them and later surfaced in the USA. In setting up the new Carl Zeiss enterprise, the managers and engineers, among which the whole Board of Directors ("Vorstand") were represented, decided to settle in Oberkochen on the basis of a suitable empty factory having produced landing gear for aircraft. 

The new location was of course unfortunate in that the vital contacts with a first-rate university, like the University of Jena, were impossible to recreate in the Oberkochen area. However, the access to major railway lines and the ample supply of knowledgeable workers ("Facharbeiter") proved to be important for the development of the new enterprise. The large representation of researchers and developers in the "immigrating" group of Zeiss-employees led to rapid development of new products, even if these were heavily based on work carried out in Jena before the move to Baden-Württemberg. The production of optical instruments in Oberkochen began in 1946. Early products in the West were stereo-microscopes, where a modular production technology was developed and introduced at an affiliated facility in Göttingen already in 1947. 

Over time, microscopes for surgeons well as other medical equipment became important products, together with photographic lenses, eyeglasses, and different types of measuring equipment. Research and development (R&D) and production in the microscope area were soon carried out in parallel in different German units, which led to a considerable degree of internal competition. This stopped to a certain extent when R&D on microscopes was moved from Göttingen to Oberkochen. A number of producers of machinery and other related supplies emerged in the surroundings of the Oberkochen factory and were to a large extent closely linked to the Zeiss group. 

In the 1980s, the Zeiss company was represented in all continents and exported 50% of production. Zeiss had over 20 overseas production plants and operated workshops, sales subsidiaries, and agents in more than 75 countries. Alliances existed with Swedish, German, American, and Japanese companies. Zeiss in 1990 had 14,453 employees of which 11,598 in Germany. Sales exceeded DEM 2 billion. The West-German Zeiss companies in the mid-1980s devoted some 10% of their turnover to R&D (Carl-Zeiss-Stiftung, 1985). Important product areas were microscopy (light & electron), surgical products for ophthalmic, neuro-, brain-, and ear-microsurgery, surveying and photogrammetry (aerial photography), industrial measurement, opto-electronic modules, and ophthalmic optics (spectacles, lenses, binoculars, and riflescopes). The companies also marketed consulting and engineering services related to large, custom-built instruments for astronomy, planetariums, laser range-finding equipment, thermal imaging, and night vision instruments (Carl-Zeiss-Stiftung, 1985). 

The East-German Operation in Jena 

At the end of the war, the Jena operations of Zeiss were for the most part destroyed during allied air raids. The future of the company was in jeopardy also due to its significant role in military production. Most of the capital equipment vanished, and in the years after the end of the war most of the scientists (including some from the University of Jena) made their way to a new facility in the West. Zeiss-Jena inherited no more than empty buildings, patent rights, and the local work-force. 

The late 1940s and early 1950s were period of reconstruction in Jena. Already in 1945, movie projectors and cameras were delivered to the Soviet Union as war indemnities. The reconstruction of the camera industry of Saxony gave a small boost to Zeiss to supply small number of photographic lenses that were not exported to the USSR. Lenses for spectacles were the first product to be sold in the domestic market. Engineers and master craftsmen from smaller firms in the Thuringia area helped Zeiss rebuild factories and machine equipment. In the 10 years following the war, Jena employees reconstructed 53 types of machines for shaping glass and metal, heavily improved and reconstructed 84 types of machines, developed and built 74 brand new types of special machines (BACZ, 1955). 

Zeiss-Jena regained a remarkable competence in optics. Unable to compete in western markets partly due to the lack of legal agreement reached with its western counterpart, Zeiss-Jena became a primary supplier of lens and optical equipment to the Soviet Bloc. The technological efforts, under the management of Carl and Rudolph Müller, came to focus on computing machines for the design of photographic lenses. Contacts were established with the Polytechnic University in Dresden, while the close contacts with the physicists at the University of Jena were maintained through a substantial annual grant. In 1950, the Zeiss works employed almost 13,000 people, busy working on fulfilling the by now established 5-year plans. Efforts were made to educate local youth and women for future work in the firm through an apprenticeship system (BACZ, 1950). 

During the 1950s, VEB Optik Carl Zeiss Jena was determined to remain a technological leader in the field. Zeiss Jena expanded from 10,242 employees to 18,554, whereof 2,300 could be characterized as involved in scientific pursuit. In 1952, VEB Optik Carl Zeiss Jena showed their first electron microscope at the Leipzig Fair. 

In the 1960s, GDR politicians under Walter Ulbricht vigorously pursued the idea of specialization under the auspices of the wave of economic reforms. They proposed that Zeiss should develop into a pure engineering enterprise. Production was to take place in other firms, and Zeiss-Jena increasingly focused on developing scientific instruments. But there were growing problems. In 1960, an internal report at VEB Carl Zeiss Jena acknowledged quality problems in production due to the urgent need to invest in important new machinery (BACZ, 1960). The insufficient allocation of resources was driven by supplier firms not fulfilling plan goals and by import restrictions. Efforts were made to have other GDR firms (like Optik-Maschinenbau, Rathenow, and Sempuco, Greiz) build standard machines, in order for Zeiss to be able to concentrate on special machines requiring leading-edge scientific knowledge. Problems also emerged in terms of energy supplies and transportation. These trends pushed Jena to subcontract most production and turn itself into a research and development, engineering firm. In 1968, VEB Carl Zeiss Jena was for all practical purposes bankrupt. The production facilities were empty, and the firm could not service its debts. 

Zeiss Jena's revival stemmed from the recognition of its potential contribution to the new economic policies of the 1970s. Throughout the 1970s and 80s, East German officials emphasized the importance of R&D and the link between science and production and ongoing rationalization of production. To aid in the rationalization of research and production, the state-owned enterprises (VEB) were gradually placed integrated into larger production units, called "Kombinate". Zeiss was transformed into a so-called "Stammkombinat," insofar that it was given the status of a Kombinat with integrated control over other state-owned enterprises. 

In 1981, the tenth Party Congress decided to give priority to the use and development of microelectronics, robotics, electronic control of machinery, and computing (Biermann, 1988). Wolfgang Biermann, the managing director of VEB Carl Zeiss Jena from 1976, in 1983 described the Kombinat's most important task as producing technological special equipment for the microelectronics industry and the introduction of microelectronics in traditional optics. Products for the Soviet space program were also of higher priority than consumer goods and components for GDR industry (Biermann, 1983). 

Biermann played an active role in transforming stagnating firm into a fast-paced East European technological leader. Small management teams that were knowledgeable of the business were formed; the Kombinat itself was divisionalized into independent profit centers to increase worker motivation (Biermann, 1984a, 1985a). To address the problems of lack of transparency and lack of control, the accounting system was expanded throughout all functions of the Kombinat. To increase coordination with the foreign trade organizations, these were partly integrated into Zeiss (Biermann 1983, 1985a). Attempts were also made to improve the relevance of the university education by increasing the focus on application and flexibility during the education of engineers and business students. 

The GDR government portrayed Biermann's leadership as a textbook example of progressive socialist management. In the still rigidly planned GDR economy with little room for flexibility and experimentation, Biermann enjoyed more latitude than most senior managers because of his closeness to the sources of political power. In Jena, production volume more than doubled from 1976-1984 using roughly the same labor force (around 50,000 employees). The export share of production was 60% (Biermann, 1985b). In certain areas like Planetariums, the Kombinat was world leading in sales. 

The growing concern of the socialist bloc countries over the rapid advancement of micro-electronic technology in the West led to severe pressures for Zeiss to aid in the development of a modern semiconductor industry. (Optics is a key component in the lithography equipment used in semiconductor production.) Zeiss was reluctant to make this entry into semiconductor equipment production. Biermann negotiated for the state to subsidize the financial costs. 

By the late 1980s, Zeiss-Jena had married optics with electronics, and became a major supplier of lithography equipment to Robotron's memory semiconductor facility. Under the leadership of Biermann, the firm tried to catch up with Western and Japanese leaders in semiconductor technology. The introduction of electronics into the traditional product lines was also carried out during this period, and major problems occurred when R&D resources were shifted from traditional optics to electronics (Biermann, 1984a). The trade embargo on exports of strategically important products imposed by the US Government also forced Zeiss to scurry for suppliers, or to develop in-house competence (Biermann, 1985b). 

The Study 

The data collection involved both public and archival sources. Initial interviews at Carl Zeiss focused on the historical development of the enterprises in Oberkochen, Baden-Württemberg and Jena, Thuringia. Archival research was carried out on-site in the corporate archives of VEB Carl Zeiss Jena. Access to the information on the Zeiss-Jena works presented an extraordinary opportunity by which to understand the evolution of organizational and technological capabilities during the period of state socialism. 

Finally, frequent contacts with German patent authorities resulted in the creation of a database of all patents granted to the Western and Eastern parts of Zeiss. The authority had recently computerized patent data for the period after 1974, which made it possible to rapidly access them. The patent data for the period 1950-1973 were not computerized, and hence were compiled manually. The change in patent recording practice in the GDR of the 1960s, where patents were assigned no longer to firms but individual inventors, posed a challenge in re-assigning patents to VEB Carl Zeiss Jena for this period. The resulting database contains information on applicants, date and country where patents were granted, patent numbers, classification (IPC-class), and priorities. The patents, which were reported in several different systems, were eventually classified and analyzed within the frame of the sixth edition of the International Patent Classification (1994) by the World Intellectual Property Organization. Patents serve as quantitative indicators of the output of research efforts. They are also act as signposts of the direction of technological effort. 

We apply a simple statistic developed by Jaffee (1986) to determine the overlap or correlation of the patent portfolios of the two Zeiss. This statistic is defined as: 

F is a vector of the proportion of patent counts in a given classification. The elements of this vector sum to 1. The numerator is the dot product of the Zeiss Oberkochen and Zeiss Jena patent portfolios. The denominator normalizes this statistic by squaring each vector, multiplying the scalar products, and then taking the square root. This statistic varies between 0 and 1, and hence is not the standard correlation. This measure is less sensitive to differences in the length of the vector than is Euclidean distance used for standard correlations. 

The patent classifications are similar to 3 digit SIC categories. The eight IPC sections can also be further broken down into 20 IPC subsections and 624 IPC classes. The Jaffee statistic is calculated at the IPC-class level and allows us to determine to what extent the technological efforts of Zeiss Jena coincide with those of  Zeiss Oberkochen. However, the correlations do not reveal the extent of their differences in the degree of technological diversification. To address this issue, we calculate Gini coefficients, as well as use more aggregated classifications in order to weight more heavily differences in broad technological efforts. The results are presented below. 

Descriptive Result 

Development 1950-1989 

The study of the two Zeiss firms in terms of patenting during 1950-1990 reveals several remarkable similarities. For the 40-year period, we record 2,355 patents by Carl Zeiss in Oberkochen, and 2,393 by VEB Carl Zeiss Jena. The distribution of patents in IPC Sections can be seen graphically in Figures 1 and 2 (see Appendix A for an explanation of what kinds of patents fall under which section). 

 
 
Physics has been the dominant IPC section in which the Zeiss firms have been patenting. Both firms have also been actively patenting in electricity, chemistry, and mechanical engineering, while Oberkochen has been more active in human necessities and Jena in performing operations and transporting. 

Insight into diversification and more refined description of technological efforts can be gained by looking at a lower level of disaggregation. Somewhat surprisingly, Zeiss Oberkochen patented in 126 of the theoretically possible 624 classes, while Zeiss Jena displayed a broader technological profile, by filing patents in 150 classes. On a simple count basis, Zeiss Jena is more diversified. 

It is important to look at the classes carefully in the two most important IPC sections of physics and chemistry. Within the section physics, both firms patented most heavily in optical elements, systems, or apparatus (Oberkochen: 723 patents, Jena: 498), followed by measuring instruments linear (Oberkochen: 210, Jena: 225). Oberkochen also figured prominently in investigation of materials (108), photographic apparatuses (107), instruments for measuring distance, levels, or bearings (90), and spectacles (53). Jena also patented heavily in instruments for measuring distance, levels, or bearings (169), and investigation of materials (127). Within the chemistry section, Jena shows a fairly even distribution between patents in IPC-classes with coating, adhesives, glass composition and crystal growth, while Oberkochen's patenting is heavily dominated by glass composition and glass manufacture. 

The effects of the late 1980 policy in the GDR to move Zeiss Jena toward semiconductor production is slightly revealed in the electricity patent activity. In the electricity section, Oberkochen's patenting is dominated by electric discharge tubes, and secondarily in devices using stimulated emission. Jena is prominent in devices using stimulated emission, electric discharge tubes, pulse technique and semiconductor devices. In other words, Jena follows very closely the trajectory of Oberkochen Zeiss, except for its diversification into semiconductor technologies. 

The correlation between the overall number of patents of Zeiss Oberkochen and Zeiss Jena in the 207 different IPC-classes is 0.943. This figure must be regarded as surprisingly high given that the two firms operated in very different political and economic systems for the entire 40-year period. They also served very different domestic and export markets. The correlations indicate that technological "push" is quite important, as well as the possibility that the two firms did not lose sight of each other's progress. We can test this possibility more thoroughly by simple lags in the correlations, as shown below. 

The Trajectories of the Two Zeiss Firms 

As can be seen from Table 1 below, Zeiss Jena's patenting has been dominated by efforts in the IPC-section physics (see Appendix A) throughout the period 1950-1990. From accounting for 70% of the patents in the 1950s, the share dropped to around 65% in the 1970s and 1980s. The share of patents in chemistry and metallurgy has been growing slowly but steadily over the period, while patents in electricity peaked at 26% of total patenting in the 1970s. In the 1980s, electricity patenting as a share was back to 1950s' levels of around 15%. 

Zeiss Oberkochen's patenting classified according to broad IPC-sections can be seen in Table 2 (See Appendix A). Oberkochen was dominated by patenting in physics over the four decades, with the share of the total peaking at 83% in the 1960s, but then returning to "normal" figures around 60-65%. The share of patents in chemistry and metallurgy increased considerably in the 1970s and remained at the 10% level in the 1980s. Unlike Zeiss Jena, the share of patents in electricity fell from almost 20% in the 1950s to 8% in the 1980s. 

The analysis of patenting in broad IPC-sections reveals surprising similarities between the profiles of the two Zeiss companies, operating in different economic systems. In sum, Zeiss Jena during the 1950s, 1970s, and 1980s seems to have concentrated its efforts in patenting to optics and measuring instruments of different kinds. Oberkochen has throughout the period 1950-1990 also focused on developing technology in the optics and glass related areas, with medical diagnosis being another important area of research and patenting. Two main differences between the companies can however be found. First, Oberkochen expanded its patenting in the chemistry and metallurgy sector earlier and faster than Jena. In the 1970s, Oberkochen's share was five times higher than that of Jena and it remained at twice Jena's share in the 1980s. Secondly, Jena increased its share of patents in electricity to be almost three times that of Oberkochen in the 1970s and kept it at twice the share of Oberkochen in the 1980s. 

If the patent data is further broken down into IPC-classes, a number of interesting observations can be made. In absolute terms, both firms diversified their technology base as indicated by patenting in more and more IPC-classes. Jena went from 20 classes in the 1950s to 142 in the 1980s. Oberkochen went from 29 to 90. For a more detailed description of the patenting profiles in the two Zeiss companies, see Appendix B. 

Correlation analysis 

Table 3 shows the correlations between patenting activities in Zeiss Jena and Zeiss Oberkochen for the 1950s, 1960s, 1970s, and the 1980s. The overall impression of the correlation analysis is the striking similarity of technological profiles between two firms sharing the same history. After 40 years of socialism and a centrally planned economy, Zeiss Jena and Zeiss Oberkochen still showed a correlation of 0.94. 

For 1970, the correlation between Oberkochen and Jena is only .72. Given the much higher correlation for the 1980s, this statistic poses a question why did the two firms deviate for just this period. The lagged correlation suggests an answer. It is useful to look at four lagged correlations of Oberkochen and Jena for the years 1970 and 1980. Note first that the correlation for Oberkochen for 1970 and 1980 is .93, whereas Jena has a correlation with itself for those years of .89. The correlation of Oberkochen 1980 and Jena 1970 is .92. This last correlation suggests that the patenting record of Oberkochen in 1980 is almost as correlated with Jena in 1970 as it is with its own patent distribution in 1970. However, the correlation between Oberkochen 1970 and Jena 1980 is .88. In other words, if one wanted to predict Jena's patenting distribution in 1980, it would be just as helpful to look at Oberkochen's patents in 1970 as it would to look at Jena's own patenting pattern for the same year. 

This statistical result stems directly from the move by Jena away from electrical patenting in 1980. But more importantly, it suggests two other possibilities. One is that Jena consciously followed the technological efforts of its West German rival. The other possibility, for which there is substantial evidence -as discussed below, is that East German policy allowed Jena more freedom in the 1980s in its research efforts, even while insisting that it deliver optical components for the attempt to build a micro-electronic industry. 

Diversification analysis 

To further analyze the patenting profiles of the two Zeiss firms, we calculated Gini-coefficients to measure the extent to which the two firms focused their technological efforts. A value of 1 indicates that a firm is patenting in only one field; a value of 0 indicates that the firm distributes its patents equally across all classes. As table 4 shows, the Gini-coefficients are consistently lower for Jena than for Oberkochen. Only for the 1980s is Jena's coefficient value is similar to Oberkochen's; Biermann's policy of focused research is apparently evident in the patent distributions. Since the Gini-index measures "inequality," the results indicate that the East German operations have shown a less focused patenting profile than the Western counterpart until the 1980s. 

The simple explanation for this result could be the necessities for Zeiss Jena to do R&D in a number of areas due to problems of purchasing necessary inputs in the market place. Jena engineers had to monitor and master a number of technical areas instead of focusing their efforts in certain narrow areas to develop superior competence. Resources (and resulting patents) seem to have been spread more evenly over the technological area where Jena was active. In the 1980s, Jena patented in more classes and the Gini-index shows that the patenting efforts were less balanced, with "inequality" in patenting going up almost to Oberkochen levels. 

A history of Zeiss Jena alone certainly confirms Schumpeter's principal point that the large socialist firm can successfully innovate. However, the comparison of the two Zeiss companies clarifies clearly two errors in Schumpeter's argument that rationalized planning could successfully replicate the industrial research laboratory of the large capitalist enterprise. First, Schumpeter assumed too readily the belief that the market socialism of independent firms interacting with a central planner would be free of political interference. Second, he underestimated the important property of the markets in providing variety and hence a division of labor that allowed firms to specialize. In this latter sense, Hayek proved the more important point, namely, that the socialist economic system collectively could not generate the emergent order that spontaneously filters and grows ideas into radical innovations. 

The historical evidence points to the negative effect of political decisions on Jena's research policies and the constraints of having to innovate by plan. In speeches to the Friedrich-Schiller-Universität during the mid-1980s (Biermann, 1983, 1984a&b, 1985 a&b), the Zeiss Jena Director Biermann spoke critically of party officials who had still to be convinced that international competitiveness should be the aim of the Zeiss Kombinat. Two speeches in 1984 are especially significant (Biermann, 1984a&b). Biermann discussed openly the problems of R&D research in comparison with western firms: 

Zeiss Jena's situation differed considerably from Oberkochen's because of its mandated role in cooperative programs among socialist countries. In addition to providing consumers with certain scarce products, Zeiss Jena was also asked to invest in research for military purposes. The military orders did have, of course, an effect on technological development, but these orders were directed to Zeiss based on its known capability; Zeiss did not create the market. 

Zeiss gradually moved its research activities -as revealed by patent outcomes-from electronics and electrical components to more traditional fields. Partly isolated from western suppliers and constrained by foreign currency, Zeiss suffered from the failure of the GDR to maintain the pace of the world market. An internal government document noted that when advanced technology is available, the GDR "can hold their own against the very best international achievements.On the other hand, these results are unattainable when this computer technology is only partially available." 

Zeiss was indeed the Schumpeterian socialist firm, invested with substantial technological capabilities but hampered by a system of central planning that dissipated innovative resources in accordance with planned targets. By 1987, the head of planning conceded that the state should give autonomy (Eigenwirtschaftung) to the most dynamic Kombinate. Biermann's conclusions were more radical. He asked the powerful Economic Minister, Günther Mittag, whether it would not be better altogether to abolish the ministry responsible for science and technology which encouraged "no strategic impulse whatsoever from the Kombinate." Whatever Mittag's answer, it came too late. 

Conclusions: 

Following reunification and the purchase of Zeiss Jena by Oberkochen, the production of small microscopes (the C-class) has moved from Göttingen in the West to Jena. The production of medical apparatus has also been moved from Calmbach in the West to Jena. These transfers of production are in accordance with the obligation by Zeiss Oberkochen to the Treuhand to keep 3,000 workers employed in Jena. In May 1995, Carl Zeiss Jena GmbH, containing the traditional parts of Zeiss' activities, was turned into a wholly owned subsidiary of Carl Zeiss Oberkochen (Scherzinger, 1996). Jenoptik AG, owned by the state of Thuringia and employing 1,200 people is to be privatized by stock market introduction in 1998. The holding integrates more than 40 small firms active in semiconductors, laser optics, impulse physics, industrial measurement technology, automation, and information technology. 

The fate of Zeiss Jena has been better than that of many other firms of the former GDR. The economic conditions of the reunification agreement created a macro-economics shock due to the sudden increase in the real wages of east German workers despite their lower productivity compared to West Germans. The elimination of all trade barriers between the two former German countries had devastating consequences on East German producers. If ever a country underwent a shock therapy by radical price decontrol, it has been the eastern states of the reunited Germany. 

The economic consequences of these policies -no matter the necessity of their political motivations- have been devastating. Despite the sell-off and liquidation of East German enterprises, the West German state has had to provide massive subsidies. By any account, the costs of reunification have been nothing short of catastrophic. 

An understanding of the technological strength and weakness of the socialist system informs an analysis of the failure of these public policies. Socialist firms in the high technology sectors did not lack, as Schumpeter would have predicted, technological capabilities, nor even clearly the managerial capabilities required for market competition. Zeiss suffered because of the inadmissibility of the plan to permit experimentations to fail. By this, it is meant that it could not rely upon the emergence of external innovations. As a consequence, Zeiss was forced, by plan, to succeed in areas in which it knew it had already failed. Zeiss was bereaved of the benefits of what Hayek called the "extended order" that constitutes the market. 

Accepting that firms such as Zeiss were impeded by the absence of the division of innovative labor in the market, it is not at all obvious that weak incentives provide an adequate or even necessary explanation for the performance of socialism and the hardships of transition. In fact, it is hard to imagine western firms spending as much time creating new incentives, and measuring them, as did managers and bureaucrats in the socialist economies. There is little evidence that managers in the GDR were deficient in their educational and technical training. 

It was not that the GDR firms were politicized insofar that they lacked economic incentives, or that the state ministries pursued political goals. They were under political pressures to fulfill the planned targets for innovation. The state ministries had only the Plan upon which to rely for the critical innovations needed for the micro-electronics policies. In many ways, socialist ministers and managers were not unlike their western counterparts who also have struggled to compete in the fast-moving microelectronics industries. 

The difference between socialism and capitalism is that the former could not rely upon the extended order to provide the innovations in the case of failure. In the absence of this insurance policy, the socialist firm could not discover its specialization. Its specialization and competence were stated in the Plan; there was no redundancy except the constrained and limited access to world markets. 

It is an error to evaluate the competence of the socialist firm entering transition without recognizing that its accumulated capability had considerable value in a system deprived of spontaneous innovation. A primary weakness of the socialist economies was the poverty of the institutions that support the coordination of economic and technological efforts by firms. Competition and specialization, price and contract, and experimentation and innovation are the substance labeled the market. The imposition of radical macro-economic change revealed firms that were insufficiently specialized in the context of the diversity that constitutes the market. From the chaos of transition may arise a new extended order built on entrepreneurial firms whose evolution is simultaneously linked to the development of the market. It is this missing link between the accumulated capabilities of socialist firms and the market that transition policies need to restore. 

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