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.
F ListBismarck

B.  Otto von Bismarck - Pragmatic and conservative leader who served as Chancellor of the North German Federation from 1867-1871 and as the first Chancellor of the German Empire that he united from 1971 to 1890. He gained support from industrial leaders with protective tariffs and outflanked his socialist adversaries by adopting the world's first comprehensive social welfare system.

The Sickness Bill of 1883 and the Accident Bill of 1884 protected workers from loss of income, finance from funds supported by employers and employees. The government verified workers’ enrollment by comparing employer records with fund membership lists, threatening employers of uninsured workers with fines. An old-age program, adopted in 1889, provided retirement and disability benefits as well.

C.  Weimar Republic - After Germany's defeat in World War I, Kaiser Wilhelm II abdicated, ending German imperial rule, and a new democratic governmental system, led by an elected President and parliament (Reichstag) was adopted at a 1919 meeting in Weimar. Unfortunately, this system was plagued by political divisions, labor unrest, and heavy reparations payments, leading to hyperinflation of about 41% per day in 1923. In November 1923, the exchange rate was 4.2 trillion marks per U.S.$.  That instability provided an opening for the rise of Hitler. 

D.  Nazis - Private property and totalitarian control.  Centrally planned economy. Inflationary monetary policies, together with wage/price controls, created shortages and required severe rationing. Encouraged cartels.  Labor unions subordinated to German Labor Front. 

E.  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, An August 2019 evaluation of 70 years of experience with the social market economy by the German firm, KfW Research, reached this general conclusion: "Since the introduction of the social market economy, the economic and social policies of the federal and state governments have combined productive competition with social balance in an exemplary manner in many respects."

F.   German Government

1.   Leadership  

ScholzChancellor - The head of government, elected by the Bundestag on the proposal of the federal President. Since December 2021, this has been Olaf Scholz from the Social Democratic Party (SPD), succeeding Angela Merkel, from the more conservative Christian Democratic Union (CDU) who was the first woman to hold the job and ruled for about 16 years. When he was young, Scholz was an avowed Marxist who wrote about "overcoming the capitalist economy" and criticized the "aggressive-imperialist NATO." Now he is considered to be a member of the centrist wing of the SPD.
President - Head of State. Technically, higher-ranking than the Chancellor, but the role has been more ceremonial in recent years. However, the current occupant, Frank-Walter Steinmeier,(also a member of the SPD) provoked controversy in early 2021 when he endorsed completing a Nordstream 2 gas pipeline between Germany and Russia. That project, of course, has now been suspended. 

2.   Parliament  

Bundestag - Alternately called the parliament or its "lower" body, made up of representatives of parties.
Bundesrat - The Federal Council, with representatives of the Lander (states). Similar to an upper house of parliament.

3.   Political Parties  

Social Democratic Party (SPD) - The center left party that now rules Germany as the senior partner in a coalition with the Greens and the Free Democratic Party (FDP). It has also ruled many times in the past, most recently when Gerhard Schröder was Chancellor from 1998-2005.

Green (GRÜNE) - Environmentalist and pro-European party that has risen enormously in elections and polls.

Free Democratic Party (FDP) - Founded in 1948, was a junior partner in coalition governments during most of the second half of the 20th century. Generally considered a centrist or center-right party that supports free markets and privatization. 

Christian Democratic Union (CDU) and Christian Social Union (CSU) - These center-right parties were the senior partners in a "grand coalition" with the SPD for about 8 years, but lost support, partly because Angela Merkel was no longer on the ballot and partly because of the slow vaccine roll-out and immigration issues, leading to their defeat in the September 2021 elections. Helmut Kohl, who led during the reunification of Germany in 1989, was a CDU member.

Alternative for Germany (Alternative für Deutschland - AfD) - Right-wing anti-immigrant populist. Its extremist wing, "Der Fluegel" (The Wing) has been under investigation as a threat to society, and the party has performed poorly in recent polls.

F.   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 engage in collective bargaining, wages in the East are now about 97% of those in the West. Along with privatization, the wage policy led to enormous transitional unemployment.

German Unemployment 1990 2018

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 rarely allowed to promote exports, to ease the adjustment problems of dying industries, or to reduce research and development costs.
The Act against Restraints of Competition (ARC), the main law prohibiting cartels and other anti-competitive practices, underwent important changes in January 2021 with new rules to protect competition in the digital economy and streamlined procedures for collection of evidence.

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 CouncilsAll firms with 5 or more workers are required to allow them, but they are created at worker initiative. So they exist only in 10% of firms, but they are the larger ones, so they cover about 40% of workers. They represent labor on most nonwage issues, such as work-place safety, employment security, the organization of working time, rules on internet use and working from home. Evidence suggests that workers in firms with works councils are more productive, and their employers are more likely to provide profit sharing and performance pay and to protect employee health.

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 , During 2002-2005, seeking a solution to the high unemployment rates that followed unification, a Commission led by Peter Hartz, the Personnel Director of Volkswagen, developed five waves of labor market reforms. These included:

  • The creation of Personal Service Agencies (PSAs) to act as agencies to place unemployed people with employers (Hartz I);
  • A grant for entrepreneurs, known as the “Ich-AG” (Me, Inc.), to encourage new businesses (Hartz II);
  • The creation of part-time job opportunities with a low threshold and minimum salary, “Mini-jobs” and “Midi-jobs” (Hartz II);
  • Restructuring the Federal Employment Agency and creation of job centres for more effectively assisting the jobless with their job searches (Hartz III);
  • Benefit cuts of up to 30 percent if a person on unemployment benefits refused to take up a reasonable offer of work (Hartz IV); and
  • The merger of social welfare benefits with long-term unemployment benefits (Hartz IV).

The good news is that German unemployment fell substantially with the reforms, and Germany continued to grow as an exporting powerhouse (although now it's being hit especially hard by the COVID-19 Crisis. The bad news is that wages have stagnated at relatively low levels and a large segment of the public hates the reforms.


C.  Apprenticeships - These date back to 1897, but operate under a law passed in 1969 that regulates the vocational training system with shared responsibility of the national and state governments, the unions, associations and the chambers of trade and industry. Required for hundreds of jobs (with 342 recognized), 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. Today, based on its earlier experience with guest workers, Germany is attempting to integrate the new wave migrants from Syria and elsewhere more effectively into society.


  IV. 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.  According to recent research by Judith Niehues:
(1) Germany has achieved a relatively high level of income equality through redistribution (confirmed by our study of data in Chapter 2)
(2) Survey data indicate that the desire for equality is above the rich-country average
(3) Surveys suggest that the population does not support additional spending on redistribution, but they underestimate how progressive the tax system is already, so they support more progressive taxes. 

OECD Redistribution (vertical) and Redistribution Preference (horizontal)

German Redistribution and Preference