Regulatory policy and social market economy
After World War II, the ordoliberal ideas of the Freiburg School were directly incorporated into West German economic policy. Although Germany was initially unable to pursue an independent economic policy because it was subject to the four occupying powers, this gradually changed after 1948.
The economic conditions from 1945 to 1948 were characterized by material hardship, the problem of integrating millions of refugees and displaced persons from eastern Germany, and the dismantling of some industrial plants as war reparations. In addition, cartels and corporations were dismantled. Of particular note was the decartelization of the sectors considered the economic backbone of the National Socialist war machine, namely IG Farben and the Vereinigte Stahlwerke (United Steel Works). During these years, the western zones first became the Bizone (American and British), later the Trizone, with the annexation of the French zone, and finally, in 1949, the Federal Republic of Germany.
Video from the Federal Ministry for Economic Affairs and Energy - "Suddenly there was everything" - 60 years of the social market economy.
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Introduction of the social market economy
As early as 1948, Ludwig Erhard, later German Minister of Economics and Chancellor, was appointed Director of the Economic Administration of the United Economic Area (Bizone). In this capacity, Ludwig Erhard implemented the currency reform in the three western occupation zones of Germany on June 20, 1948. In doing so, he succeeded—without first obtaining the approval of the military governments—in combining the monetary reform with a comprehensive economic reform. For Erhard, the purpose of the currency reform was to provide an initial impetus for the German economy. Not only did the money supply and the supply of goods have to be brought into line, but real trade was also to develop. However, the existing control measures and price controls stood in the way of this. Consequently, Erhard lifted the control of industrial products on the first working day after the currency reform. This meant that goods released for sale on Monday morning, such as household items made of wood and glass, typewriters and sewing machines, automobiles, bicycles, etc., could already be purchased for the first installment of the Sunday bounty on Monday morning. The liberalization of further prices was carried out consistently but cautiously. To prevent unnecessary price increases for food, for example, maximum price regulations remained in place for the time being.
The successes of the currency reform were clear: On the very first day, shop windows were filled with goods, brisk trade developed, and black markets disappeared. However, significant price increases also occurred. Furthermore, there was considerable unemployment. Accordingly, public opinion about Erhard's reforms was still very divided after a few weeks. Nevertheless, the currency reform was the first step in the transition to a market economy in West Germany.
When Ludwig Erhard became Minister of Economics in a coalition government consisting of the CDU and several smaller conservative and liberal parties, he and his State Secretary Alfred Müller-Armack popularized the new economic system based on the ideas of ordoliberalism, which was now called the "social market economy." Since the main opposition party, the SPD, largely opposed the market economy at this time and communist East Germany waged a propaganda war against it, the label "social" became important to demonstrate the positive social consequences of the market economy. It was not until 1959 that the SPD accepted the market economy in its new party platform.
Since the introduction of the “social market economy” was a great success, the associated expansion of the German economy was even called the “economic miracle,” a term that Ludwig Erhard never particularly liked.
It is thanks to Erhard's long-standing consistency that the implementation of his regulatory ideas was at least largely successful. As early as 1949, the Federation of German Industries (BDI) opposed Erhard's competition policy, and after the outbreak of the Korean War, American economic advisors called for an immediate end to foreign trade liberalization and a return to economic control measures. However, none of this was an option for Erhard. He believed that establishing a market economy was a fundamental decision that could not tolerate compromises determined by organized interest groups.
On the path to the social market economy, Ludwig Erhard therefore also experienced several setbacks, for example, the creation of an exceptional status for agriculture in the EEC. It is also significant that the foundation of the competitive economy, namely the guarantee of competition through competition law, proved to be a difficult undertaking. It was not until 1958, ten years after the market reforms began, that the "Law against Restraints of Competition" came into force. This shows that the model of the social market economy, as created by Ludwig Erhard and Alfred Müller-Armack on the basis of the ordoliberal principle of order, should not be confused with the economic policy reality in West Germany. Already during the 1950s, economic reality was increasingly moving away from the ordoliberal ideal. Since then, there has been a steady shift away from the principle of universal rules of the market economy in Germany. While in the first phase of the social market economy most laws were simple in nature and universally applicable, the German governments increasingly—and today almost exclusively—concerned with special cases and particular interest groups. Germany developed into a welfare state.
In an interview from 1963, Ludwig Erhard commented on the social market economy as follows:
Sources / Literature:
Schlecht, Otto; Stoltenberg, Gerhard (eds.) –Social market economy: fundamentals, development lines, perspectives, Freiburg 2001.
The path to the welfare state
Since 1948, a successful market economy system, the "Social Market Economy," has been established in western Germany based on the ideas of the Freiburg School and Ordoliberalism. Since then, however, the German economic system has changed considerably.
The regulatory approach lost much of its influence on the social market economy in Germany decades ago. Instead, Keynesianism, which was fashionable in the Western world, was viewed as an instrument for improving long-term economic development since the economic crisis of 1966/67 (with 2.1% unemployment!) and the resulting political change. Since that year, the "Stability Act" has formed the new basis of German economic policy. It is characterized by the goals of the "magic square" (price stability, full employment, appropriate growth, external balance) and—in keeping with the Keynesian approach—by the government's commitment to countercyclical fiscal policy. Added to this was the "concerted action" initiated by the then Minister of Economic Affairs, Karl Schiller (discussions between the government, trade unions, and associations on a "cyclically appropriate" distribution of the gross domestic product).
This marked the definitive departure from ordoliberal thinking. Although the crisis of 1966/67 was quickly overcome, it can hardly be said that this proves the effectiveness of Keynesian measures. Moreover, the initial supposed successes of this policy were quickly undone by the oil price shock, stagflation, and rising unemployment – coupled with rising national debt. Although the Keynesian concept quickly failed, the state retained the newly prominent position it had created for itself in the German economic process, especially in the eyes of the German population, who still see the state as primarily responsible for satisfactory economic development.
The contrast between Keynesianism and liberalism is shown in the modern Keynes vs. Hayek rap battle "Fear the Boom and Bust":
Germany has changed significantly, particularly with regard to the definition of state functions: the state is no longer primarily protective and productive, but has assumed a significant distributive mandate. This mandate is difficult to define through the constitution and has allowed interest groups increasing influence. The consequences for citizens become clear, for example, through a comparison of gross and net incomes over the last 50 years: While an employee in the Federal Republic of Germany earned a mere 243 DM per month in 1950, of which they had to pay 11 DM in income tax and 19 DM in employee social security contributions (12.3%), the average salary had already risen to 4,270 DM per month by 1999, but now taxes and social security contributions of 36.5% were due.
This development is not surprising. The American economist Mancur Olson has impressively demonstrated how a private law society can develop into a social or welfare state. His theory of collective action shows that the organizability of interests in a society depends heavily on the size of the affected group and the incentives within it. The larger a social group, the smaller the individual's share of the benefits of the group they are working for. The incentive for this engagement is therefore quite low. Therefore, political entrepreneurs seeking to organize collective action are more likely to be successful if they organize relatively small and homogeneous groups. In the absence of selective incentives, the incentive for group action decreases with increasing group size. Therefore, it is small groups that can use lobbying to pressure ruling politicians to divert resources to secure a larger share of the social product for themselves. There is no country that achieves a symmetrical organization of all groups with a common interest and thus finds "optimal" results through comprehensive negotiations. Instead, in stable societies, there will be an accumulation of collusions and organizations for collective action over time.
This is leading to a far-reaching change in the institutional framework in market economies, including the social market economy in Germany: Due to the growing number of interventionist interventions in the economic process, it is increasingly difficult to speak of a consistency in economic policy. Confidence in economic policy is declining. The functionality of the price system is significantly reduced by a large number of direct and indirect market interventions. These include, for example, minimum prices (e.g., on the labor market) and subsidies for specific sectors of the economy. Politicians can win votes, especially by subsidizing stagnating or shrinking industries that should actually lay off a large part of their workforce. In doing so, however, they also distort the price system. Another option for protecting these industries is the creation of various types of import restrictions. This transforms formerly open markets into closed markets with oligopoly- or monopoly-like characteristics. The distorted market outcomes thus created are often politically undesirable, necessitating further government intervention due to so-called "market failure." These can include renewed subsidies or price distortions, but also restrictions on freedom of contract. Increasing redistribution and social security also reduce the extent of liability that individuals must bear for their actions. Thus, economically "wrong" decisions made by individuals or companies, because they are unsuccessful, immediately trigger a demand for state compensation from the affected group, especially if the groups are well-organized.
As the system of indirect benefits and regulation becomes more complex, so does the need for administration and bureaucracy. Lobbying by organized special interests and politicians' attempts to establish opaque redistribution mechanisms increase the scope of government activity. This leads to increased government production activity and, to finance it, increased taxation of private income and assets. This, however, increases the incentive to migrate to the shadow economy or other economic systems (Eastern Europe, East Asia, the USA, etc.). Furthermore, citizens' willingness and ability to save decreases, which also implies lower investment activity.
The growth of distributional coalitions and political and economic collusion, the increase in state activity, and the growing complexity of redistribution mechanisms change the incentive structure in a society. For example, a high tax burden can reduce the incentive to produce, while increasing the incentive to obtain a higher share of output. The positive sanctions for performance in the sense of market performance then decrease, while they increase for performance in the sense of circumventing and exploiting state redistribution and regulation. However, such a change in incentives in a society steers its evolution in the wrong direction. The result is no longer a society that favors the weak, the poor, and the less talented. Rather, the better-adapted, i.e., those who can best exploit the welfare state, benefit from the system. Welfare state institutions therefore promote a mentality characterized by entitlement and risk aversion. In a welfare state, therefore, many perverse incentives and misallocations occur. Competitive self-regulation and with it the adaptability and development capacity of the economic system are adversely affected.
The welfare state is currently the subject of debate in Europe. However, even with an understanding of what is necessary, governing politicians find themselves in a dilemma; their reform initiatives can always be blocked or restricted by the opposition, using the argument of "dismantling the welfare state" or a lack of "social acceptability" for their own political advantage. Reforming a welfare state is therefore a difficult undertaking. However, the process of globalization, and the international competition for capital and knowledge, is increasing the pressure on all welfare state systems, and thus on the politicians in power there, so much so that sooner or later, a far-reaching reform will be implemented in Germany as well.
Sources / Literature:
Bernholz, Peter -Some remarks on the theory of the influence of associations on political decision-making in a democracy, in: Kyklos, Vol. 22 (1969), pp. 276-288.
Bernholz, Peter -Causes of Change in Political-Economic Regimes, in: Lüder Gerken (ed.): Competition among Institutions, Freiburg 1995, pp. 65-88.
Olson, Mancur -The Logic of Collective Action. Public Goods and the Theory of Groups, Cambridge 1965.
Olson, Mancur -Rise and Fall of Nations – Economic Growth, Stagflation and Social Rigidity, 2nd edition, Tübingen 1991.
Seliger, Bernhard -The crisis of social security and globalization – political myths and regulatory reality, in: ORDO Yearbook 2001, pp. 215-238.
Seliger, Bernhard -The Second Advent of Eurosclerosis? The Problematic Future of the European Union, in: Korean Journal of EU Studies, Vol. 6 (2001), No. 1, pp. 151-192.
Reforms in the welfare state
The "Intellectual and Moral Turnaround" of 1982
It was not until the beginning of the 1980s that a government emerged that rejected Keynesianism and returned to a supply-side economic policy. The government under Helmut Kohl was able to improve the national debt situation through a restrained fiscal policy up until the time of German reunification. The federal government's net borrowing had already fallen significantly in 1982, and the government's share of GDP was continuously reduced in the years that followed. On the other hand, two crucial areas of economic policy were left almost untouched: social security and the labor market. It was precisely in these areas that Germany's main competitors in the international competition for business locations (e.g., Great Britain) crushed interest groups and implemented reforms. In Germany, however, these special interest groups even succeeded in expanding their positions of power. From an economic policy perspective, the "turnaround" of 1982 must therefore be considered a failure, at least in part.
Even after the unification of the two German states, regulatory approaches were not activated; the sclerotized West German economic and social system was simply transferred to the new federal states. After a brief "unification boom," structural economic problems returned to the forefront. A return to the ordoliberal concept of the social market economy has been a long way off since then.
Agenda 2010(2002 – 2005)
After the red-green federal government under Chancellor Gerhard Schröder reversing the reform initiatives of the previous government in 1998, the government drafted a highly controversial reform package known as "Agenda 2010" in its second legislative period. The three most important areas of Agenda 2010 are tax reform, pension reform, and healthcare reform. Thus, the concept is, on its face, quite comprehensive and ambitious.
In 2004, the first step of tax reform was implemented, reducing the entry tax rate to 16 percent and the top tax rate to 45 percent. The following year, these rates fell to 15 percent and 42 percent, respectively. The government estimated the tax savings for citizens at approximately €21.5 billion.
The pension reform of Agenda 2010 consists primarily of a temporary suspension of pension adjustments with the aim of stabilizing pension contributions at 19.5 percent, as well as a long-term modification of pensions using a so-called "compatibility factor." The latter, however, simply means adjusting pensions to wage trends, i.e., pensions increase more slowly. Given the rapidly growing population, there is no other option than radical reform. It is paradoxical, however, that these changes were already planned before the change of government in 1998 and were then halted by the same government that is promoting them today as part of Agenda 2010.
The first steps in health care reform were also implemented in 2004, but their goal of reducing the average health insurance contribution from 13.6 percent to less than 13 percent failed. Other aspects of Agenda 2010 include reducing government bureaucracy and measures to facilitate simultaneous employment and child-rearing for mothers.
Agenda 2010 is undoubtedly the most important reform of the Schröder government, but from a regulatory perspective it is only a beginning and in many respects not very promising. A comprehensive transformation of all areas in need of reform – the labor market, the pension system, and the healthcare system – has not been achieved. Precisely because only the financial viability of certain measures is being discussed, a crucial aspect of the problem is being ignored: setting the right objectives! First, the reforms must contribute to re-establishing a functioning pricing system, opening up the markets, and establishing economic freedom and appropriate liability rules. Where private markets, such as the insurance market, function better than an entrenched welfare state system, clear liberalization will require less or no public support at all. Deregulation in these areas is almost always more successful than extensive government spending programs.
Here is a report on Chancellor Gerhard Schröder's government statement on "Agenda 2010" from March 14, 2003:
Hartz legislation(2003 – 2005)
To reform the labor market—or rather, to reform unemployment administration—the Schröder government established a commission chaired by VW executive Peter Hartz. The so-called Hartz Commission developed the following proposals, which were implemented in three stages:
In January 2003, the so-called Hartz I and Hartz II laws were passed. They made marginal employment tax-free and supported the "Ich-AG" (one-person company). They also made marginal employment tax-free and exempt from social security contributions up to a certain income. Income above this threshold is taxed gradually until the standard rate is reached. Further training measures are also supported. Currently, 7.6 million people are in marginal employment. It is paradoxical that the Schröder government, which originally strongly criticized tax- and social security-free employment, now presents it as one of the mainstays in the fight against the high unemployment rate.
In January 2004, Hartz III, a labor market reform law, was passed. It brought about significant improvements, particularly fewer inflexible termination conditions and a reduction in entitlements to unemployment benefits. This was the first time in a long time that it was recognized that comprehensive protection against dismissal discourages hiring. However, the measures implemented were still inadequate and therefore hardly led to a significant reduction in the unemployment rate in Germany. Hartz III was also intended to improve employment administration. The Federal Employment Agency was overshadowed by scandals during this period, including irregularities in the statistical recording of placed unemployed people. The new Federal Employment Agency is to focus on placing unemployed people in job openings rather than on calculating unemployment benefit entitlements. The success of this restructuring, however, is questionable. Simply renaming—and perhaps restructuring—the extensive employment administration bureaucracy does not guarantee administrative efficiency. Furthermore, it will not create new jobs in Germany.
Hartz IV, the final part of the labor market reform package, was passed into law in January 2005. It is the most significant and demanding part of the reform. Since January 2005, there has been no longer any duplicate bureaucracy for administering unemployment benefits (for the long-term unemployed) and social assistance (for everyone else). In addition, cuts to support services have also been made. Counseling for the unemployed is to be strengthened in parallel. Even more important is the "support and demand" concept, which allows for the reduction or even suspension of benefits for unemployed people who are unwilling to take up suitable work. Of course, it is difficult to define the term "suitable work" precisely. However, to date, the unwillingness of many unemployed people to accept lower-paying jobs has been one of the reasons why it has not been possible to get many unemployed people back into work.
The Hartz legislation was certainly a correct and important step towards reforming the German welfare state. However, it was not embedded in any overall plan, as Agenda 2010 was also only piecemeal. This meant that the Hartz legislation had little effect. Quite the opposite: in places where there were hardly any job vacancies, for example in eastern Germany, Hartz IV in particular provoked considerable resistance. This type of labor market reform would have been much easier to implement if the supply of job vacancies had been significantly improved at the same time, for example through comprehensive tax relief for small and medium-sized businesses. As a standalone reform measure, however, Hartz IV represented only a stumbling block for the Schröder government.
Sources / Literature:
Federal Government (2004) Agenda 2010, on the Internet: http://www.bundesregierung.de/en/News-by-subject/Agenda-2010-,11608/Agenda-2010-an-overview.htm (accessed on February 15, 2005).
Council of Economic Experts (2004) Annual Report 2004/2005, Successes abroad - Challenges at home
Seliger, Bernhard (2001) Reforming the Welfare State: German and European Experiences and Challenges, in: International Area Review, Vol. 4, No. 1, pp. 63-87.
Wünsche, Horst-Friedrich (2005) From the coalition agreement to the government declaration: steps towards the revitalization of the social market economy?, in: Orientations on Economic and Social Policy, Issue 106, December 2005, pp. 11-17.
Challenge of German unity
The unification of the two German states in 1990 was, and still is, an enormous challenge for German economic policy. It was clear that the transformation process in eastern Germany would not be completed with the introduction of the Deutsche Mark in the summer of 1990 and the complete, with few exceptions, transfer of the West German economic and legal system. However, fundamental regulatory errors were made – and continue to this day!
The development in East Germany is shown in a video by the German Economic Institute on the topic "East Germany - 25 Years after the Reunification"
The Kohl government (until 1998) attempted to revive the collapsed East German economy with immense transfer payments from West Germany. However, the upswing in East Germany was short-lived. Approximately tens of hundreds of billions of euros were spent solely on consumption and not invested in new infrastructure or education. Therefore, while income levels in East Germany today are approximately 90 percent of those in the West, per capita gross domestic product is only 65 percent. This gap continues to be financed through transfers. However, the East German economy was thus driven into permanent dependency and degraded to a "charity economy."
It is particularly regrettable that the opportunity presented by German reunification was not seized to "clear out" and simplify the now pan-German legal and economic system. This meant that a flexible market-based system could not develop in the new federal states. Instead, with a few minor exceptions, the rules and regulations accumulated over decades of West German "welfare stateification" were transferred in their entirety to East Germany. Institutions—i.e., legal regulations and personal behavior patterns—of a sclerotized welfare state clashed with the remnants of a socialist centrally planned economy. Other Central and Eastern European states have developed more successful strategies in this regard. In the absence of a "big brother," there was a clear pressure to implement clearly market-based reforms. Countries such as Estonia and the Czech Republic, among others, which underwent radical market reform, are therefore now recording higher growth rates than the new federal states in eastern Germany. A sense of crisis no longer prevails here—quite the opposite.
In eastern Germany, millions of people lost their jobs during the restructuring process. However, they were prevented from finding new jobs by the high wage level and the density of regulations. Since the costs of unemployment and all social benefits must be financed by the economically active population, their burden also increased in the form of higher taxes and, in particular, social security contributions. While gross wages have continued to rise in recent years, so have labor costs, so that more and more people across Germany are being excluded from the labor market. The result is enormous migration movements within Germany. While this can be understood as "successful passive restructuring," it rather clearly demonstrates the failure of the previous subsidy policy.
German unification in 1990, like the transformation of the other socialist centrally planned economies, was neither anticipated nor prepared for by academics nor politicians. The political constraints resulting from the threat of mass emigration to western Germany placed policymakers in a difficult position during monetary union and the introduction of the new social security system, making many economically problematic decisions appear politically unavoidable. Nevertheless, this cannot justify the continued subsidy economy in the new federal states. Germany's economic crisis, particularly in the new federal states, has also been characterized by a changed international environment since the 1990s. Globalization and EU enlargement put the German economy under greater pressure than before. Companies took advantage of the opportunities offered by emigration – and thus also secured jobs at home! However, German economic policy remains helpless in the face of these realities. Instead of seizing the opportunities offered by increasing internationalization, globalization and the EU's eastward expansion have become bogeymen. Due to the German reform backlog, unemployment actually continued to rise. The catching-up process initiated in eastern Germany in the early 1990s thus came to a complete halt. Parallel to a general reform of the German welfare state, a reform of the "reconstruction of the East" program must therefore also take place. Previous approaches have not been in line with the principles of a market-based transformation policy, but rather with the old Western European concept of welfare and redistribution.
Quellen / Literatur:
Seliger, Bernhard; Wrobel, Ralph (2000) German Unification: the Valuable Lessons, in: The Baltic Review – Quarterly Magazine, Vol. 20, 2000, S. 8 – 11.