Germany: Unifying the
Social Market Economy

I.    The Historical Legacy

A.  Friedrich List (1789-1846) Early advocate of German unification. Exiled to U.S. in 1825; became citizen, businessman, statesman, influenced by Hamilton. Returned to Germany, supported creation of Zollverein and external protection.

B.  Otto von Bismarck - Pragmatic chancellor (1871-90) who united the German states.  Developed protective tariffs and comprehensive social welfare system. 

C.  Nazis - Private property and totalitarian control.  Used rationing, quotas, wage/price controls, encouraged cartels.  Labor unions subordinated to German Labor Front. 

D.  The Social Market Economy

      Based on the economic philosophy of Ordoliberalism from the Freiburg School. First implemented by Ludwig Erhard, Minister of Economics from 1949 to 1963. 

1.   Market system would coordinate economy; planning and fine tuning ruled out.

2.   Monetarist program adopted for price stability and supply side investment incentives were used to encourage growth. 

3.   Cartel laws to prevent monopolistic practices and preserve competition. 

4.   Social welfare programs adopted in the tradition of Bismarck.

UPDATE: Article 3 of the Treaty on European Union, activated in 2009, says that the whole EU will "establish an internal market. It shall work for the sustainable development of Europe based on balanced economic growth and price stability, a highly competitive social market economy, aiming at full employment and social progress, and a high level of protection and improvement of the quality of the environment."

UPDATE, October 2013: "Secrets of Germany's Economic Success"As a rule, the economic system is usually fairly important to an economy's success. That, after all, is what creates the conditions for a country's economic activities. In Germany, this system is a "social market economy" - on the one hand, it is based on capitalist competition, but on the other hand it still allows the state to provide social correctives.

E.   Unification

1.   Beginning 

November 1989 - Opening of the Berlin Wall
March 1990 - New E. German govt. creates Treuhandanstalt
May 1990 - West established "Fund for Germany Unity"
June 1990 - West controls Treuhandanstalt, prices released
July 1990 - Monetary system unified
October 1990 - Political union

2.   Monetary Union.

a.   Immediate or flexible rate transition? Dramatic leap chosen to stop massive immigration from East to West.

b.   What rate(s) of exchange? Maintain Eastern competitiveness, or asset values? Choice: range of rates from 1:1 on salaries and pensions to 3:1 on claims of individuals living outside Eastern Germany - average effective rate of about 1.8:1.

c.   Wages in nationalized sector? W. German unions insisted on quick equalization.  In the larger firms that enage in collective bargaining, wages in the East are now about 97% of those in the West. Unemployment.

German Unemployment

3.   Privatization

a.   Wolfgang Ullman, East German theologian and agitator, called for holding company to take possession of state property, and gradually redistribute to E. Germans with vouchers.

b.   Instead, Treuhand fell under control of West, initially attempted restitution, then rapid sales to strategic investors. This system was quick, attracted capital and skill, but not transparent.

 German Convergence

 II.  Industrial Organization

A.  Cartels - Supported by Bismarck & Hitler to control world markets.; control prices and market conditions.  After World War II a movement started to dissolve the cartels.  Still allowed to promote exports, to ease the adjustment problems of dying industries, or to reduce research and development costs.

B.  Lack of entrepreneurs - Workers and investors favor stable industries, traditionally dislike "gambling."


III. The Labor Market & Labor Relations

A.  Collective Bargaining - Only 18 percent of the labor force unionized, but 60% of employees in Western Germany and 47% in Eastern Germany are covered by collective agreements.  Closed shop is illegal. Unions represent large groups of workers in broad industrial groups; are generally moderate.

B.  Codetermination

1.   Works Councilsrepresent labor on most nonwage issues, such as work-place safety, employment security, the organisation of working time, rules on internet use and working from home;

2.   Supervisory Boards—provide overall guidance to the company and appoint the management board that handles day-to-day decisions. Labor representatives hold 1/3 of positions in firms with over 500 employees and 1/2 positions in firms with over 2,000. Little labor influence on general corporate policy.  Labor reps concerned with continued prosperity of the company. 

3.   Supporters: codetermination has maintained peaceful labor relations.  Critics: it threatens private property.

UPDATE, October 2013:"Germany can keep VW veto law" Germany defeated the European Commission in the top EU court to shield VW from takeovers. Lower Saxony supports protection of jobs and labor's role in corporate decision-making, which they say has fostered VW's rise to become the world's third-largest carmaker in 2012... The VW law has often been cited as an example of Germany's model of consensus-based industrial relations. The company's 20-member supervisory board is evenly split between management and labour representatives, an expression of VW's belief in what it calls "co-determination". Most of VW's 104 global plants have works councils... that discuss personnel issues and working conditions with management. VW has exported that principle across the globe, though is currently facing difficulties setting up a labor representation body for workers at its U.S. plant in Chattanooga, Tennessee.

C.  Apprenticeships - Required for hundreds of jobs, it involves 2/3 of mid-school grads. Lasts 2-3 years, some work on-the-job and some in training centers, ending with national exam.  Years later, another exam to become "meister." Financed by industry/government. Curriculum developed by industry, unions, and educators. 50-80 percent of apprentices stay with training companies; low teenage unemployment.

D.  Guest workers - Recruited for low-skill positions during labor shortage of 1960s.  Play vital role in sanitation, construction, hospitals, etc.  When unemployment rose in 1973, ban imposed on further recruitment.  In 1983, Parliament offered prepaid social benefits to workers who returned home. Flood of immigrants and return of Germans after communist collapse led to violence, caused government to tighten restrictions.

E.   Active Labor Market Policy - Reduction of spending is major cause of higher unemployment now in East.



IV. Financial Markets

A.  Bundesbank- Highly independent  Prime function is to "safeguard the currency."

B.  Saving incentives - The government encourages savings and investment by allowing workers to save in seven-year tax free accounts with subsidized interest, by a savings program for home down payments, by an absence of a capital gains tax, and by maintaining a low inflation rate.

C.  The Banking Sector - The largest banks are all purpose banks; they can broker securities, underwrite stock and bond issues, and provide investment counseling.

D.  Securities Markets - Play relatively small role in the German financial system.  Frankfurt has the largest exchange.  Bond trading is about six times that of stock trading.  Banks are the largest issuers and owners of bonds.  Most German companies finance through bank lending and have high debt-to-equity ratios.


 V. The Governmental Sector

A.  Fiscal Policy and Planning - Initially after World War II, rejected Keynesianism and established supply-side fiscal policy.  Later, more use of stabilization, but returned to a supply-side policy in 1982.  Kohl administration has tried unsuccessfully to reduce the governmental share of GNP and cut taxes.  Presently, trying to cut some governmental and company-based social benefits.

B.  Monetary Policy – Before the adoption of the Euro, the Bundesbank maintained a strong monetarist stance.  Germany had the strongest anti-inflation record of all Western industrial nations. 

C.   Redistribution of Income - Under Bismarck, programs established for insurance against sickness, accidents, elderly and disabled, and for widows and orphans.  Unemployment insurance adopted after World War I.  After World War II, system of social welfare programs.  Today, includes maternity grants, "child care vacations" for new mothers, family allowances for families with school age children, free university educations for many.  Unemployment insurance covers agricultural and at-home workers. The tax system is based on regressive consumption taxes and apparently contributes to income inequality.