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

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.

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.  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.

 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, dislike "gambling."

III. The Labor Market & Labor Relations

A.  Collective Bargaining - About 35 percent of the labor force unionized.  Closed shop is illegal. Unions represent large groups of workers in broad industrial groups; are generally moderate.

B.  Codetermination –

1.   Works Councils—represent labor on most nonwage issues;

2.   Supervisory Boards—labor representatives hold 1/2 positions. 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.

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.

      UPDATE:  Financial Times, July 13, 2001. Gerhard Schroder, Germany's chancellor, yesterday underlined his strong opposition to greater labour market flexibility. "We don't want an American-style labor market because we believe a higher level of (job) security and certainty is right…" Such flexibility "contradicts the German and European tradition", he said.

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.

Table 11.2 (update) 
Unification of Germany:
Growth, Unemployment,
and Inflation, 1990-2004

Sources: Deutsches Institut für Wirtschaftsforschung, Economic Bulletin No. 5, 1995; No. 8, 1998; No. 5, 2001; No. 1, 2003; and Deutsche Bundesbank, Monthly Reports.