TCS Daily

The German Miracle?

By Nico Wirtz - March 17, 2004 12:00 AM

Germany's predicted economic recovery has a shaky basis as long as the country's domestic economy has no internal driving force. One essential reason for this criticism is a misguided policy that leaves too little economic latitude, chokes the labor market with its bureaucracy, and burdens its citizens with excessive taxes and contributions.

At the same time, this criticism hints at the sober, while in Germany highly explosive, declaration that federalism without competition is not really federalism at all. There should be no doubt that the path to more growth and high employment rates requires not only compromises as far as the distributionist scheme of the welfare state is concerned, but also a revitalization of general competition and subsequently more freedom of choice.

Germany's comparatively short work week, as well as the numerous holidays and vacation days that drive up labor costs compared to the international market, contribute considerably to the desperate economic situation. Conditions on the German labor market not only hamper employees' ability to find new jobs or change jobs, they also weaken commitment and morale among those who stay in their jobs because they resent the excessive personal tax and contribution burden.

Ultimately, the legal framework reflects the measure of personal and economic freedom that exists. Contrary to the global trend, personal and economic freedom is decreasing in Germany. Studies conducted by the World Economic Forum (WEF) and the Fraser Institute concluded that Germany's position in a ranking of 123 countries has been slipping continuously for years. In both indices, Germany ends up in a pathetic 20th place, on a par with Chile and Mauritius - and is trending downward!

A clear indicator for Germany's development, along with the low growth rate of the "official" economy, is a rapidly expanding "shadow economy". In spite of the problems inherent in the German economic model, the labor market has become even more rigid since the beginning of Chancellor Gerhard Schröder's first term in office. Even the salient points of his Agenda 2010 will not obscure the fact that labor and economic policies are misdirected. Instead of solving the problems, Agenda 2010 only postpones them.

It is obvious that fiscal policy in the coming years will be preoccupied with lowering the massive public deficits to a level compliant with the Maastricht treaty. There will be no way around drastic reforms. What the country needs are cuts in spending combined with tangible tax cuts, not (indirect) tax increases, as planned in many areas. The social security systems are mired in permanent financial troubles. Schröder's Agenda 2010 does not create the urgently needed economic latitude -- neither on the labor market, nor in the area of social security. It might be a fix for the short run, but it presents no viable medium- and long-term alternatives to creating personal and economic freedom that is so desperately needed to revive the German economy.

In view of the German labor market's downward trend outlined above, the following question has to be asked and answered in more detail: Does the current situation show the anachronism of the Social Market Economy concept and does it prove this model's failure, or are we only looking at the outgrowth of the concept attributed to Ludwig Erhard? An outgrowth that has nothing to do with the original idea of Social Market Economy?

The German public first viewed capitalism of the Anglo-Saxon pattern with skepticism. Ethical criticism prevailed that assumed negative social consequences of individualization, consumerism, economization, and social disintegration. The era of the Weimar Republic was characterized by heavy state regulation, which in part - as was the case in the U.S. - magnified the economic crisis. After World War II, the concept of Social Market Economy was supposed to be the basis for a new social contract between labor and capital. It became the intellectual foundation for the interaction of liberal economic leaders on the one hand and conservatives, for the most part church-oriented, on the other side of the emerging CDU party.

The Social Market Economy concept had two central aspects: 1) Decontrol to a certain degree of market processes, and 2) an institutional framework of government "Ordnungspolitik," an orderly structure of rules for the economy, designed to steer market powers and compensate for undesirable effects of liberalization. Although the original concept of Social Market Economy speaks of all social forces as "order-giving potentials," the government has, over the course of time, turned into a monopoly of Ordnungspolitik.

Soon, the "Social Market Economy" began to move away from the free market to more government regulation, a situation that began to burden the economy all the more once the global economic environment changed in the mid-1980s. In view of the definition of "Social Market Economy," shaped by Alfred Mueller-Armack, this development is hardly surprising. Mueller-Armack saw in "Social Market Economy" an economic system that "... in the framework of a market economic order strives toward social justice ..."This definition, however, allows much room for different interpretations and different political ideas. The term "social justice" in particular can be interpreted at will. It was primarily the opinion that the state must correct social and economic imbalances that contributed to the rigidities in the German labor market outlined above.

Despite all warnings by liberal theorists, Marxist socialism as well as economic and socio-political interventionism, which had shaped the political landscape in the inter-war-years, resurfaced in the young German Republic. Erhard, often dubbed "father of the German economic wonder" and identified with the term Social Market Economy, feared the excessive interventionism in economic and social policy in the early phase of the Federal Republic. As a representative of Ordo-liberalism, a German variant of Neoliberalism, he was, as a matter of principle, opposed to government intervention to safeguard "social justice".

The interpretation of Social Market Economy and actual German economic policy has changed considerably since the beginning of the 1960s. The social justice aspect resurfaced and, contrary to what Erhard believed, has come to play a central role in the interpretation of Social Market Economy. While there is no common ground as to what social justice actually is, Social Market Economy seeks to strike a balance between the efficiency of market economy and social stability and attempts to shape a liberal economic order according to political rules which then fulfills certain criteria of social justice. Such an interpretation of the concept is reminiscent of a combination of "free" market economy and welfare repair service.

In his interpretation of the term "Social Market Economy," Erhard sided with the German Ordo-Liberals: Government creates the regulatory framework in which economic and labor activities take place and withdraws more and more from the market process. The market economy is "social" by nature, and the need for classical state welfare policy decreases as prosperity increases. The more affluent a society becomes the better its citizens can take care of themselves.

While Erhard considered the tax and contribution burden too high as early as the 1950s, Social Democrats and factions among the Conservatives, emphasizing the great significance of the modern welfare state, did not shy away from expanding government services financed through taxes. As early as 1962, Erhard criticized the Federal Government's excessive social and regulatory policy. He exposed the revision of the pension scheme and introduction of the so-called "dynamic pension" in 1957 as part of a short-term political plot aimed at winning the election of 1957, and in his book Wohlstand für alle ("Prosperity for All") gave a prophetic warning:

"Economic freedom and politically enforced insurance coverage are like fire and wate.... It seems particularly difficult to understand... the desire to safeguard what has been attained against all adversities of the future...This is a truly tragic error because people obviously don't want to recognize that economic progress and prosperity based on performance are incompatible with a system of collective security."

The new understanding of social market economy consisted in revitalizing state intervention, which Erhard believed to have been overcome, in the smallest areas of economic and social policy. This political direction went hand-in-hand with a drastic expansion and creation of welfare services, which promptly resulted in a massive increase of the public sector share in GNP, which had been 30.8 percent in 1950 and had by 1989 exploded to 49.8 percent. At the end of the 1990s, the public sector share in GNP had risen to over 50 percent.

As early as 1974, Erhard declared the time of Social Market Economy over because what had become of "his" Social Market Economy was far removed from his view of freedom and individual responsibility. The transformation of the Social Market Economy of the 1950s into a welfare and all-providing state was at that time in full gear. Erhard's concept was replaced by the concepts of Globalsteuerung (global macro-economic policies), overregulation, regularization and the welfare state. The implementation of "social justice" by means of regulatory, insurance, tax, and transfer policy has become more important than sensible economic policy. Nowadays, politics alone decides what is economically viable or "socially just."

Unless there is a drastic reduction of the public sector share of GNP and - at least - a limitation of the government's economic intervention, there can be no economic upswing. Along with radical reforms in budgetary, tax, and health policy, changes in the labor market are desperately needed. The country needs to decrease the government's financial and tax burden for labor, set a time limit on unemployment benefits, reform the welfare structure so that more people are employed in low-wage jobs, encourage economic and political competition between the individual states (federalism) to boost individual job mobility, and institute a more flexible collective wage policy. The inflexible collective wage agreements in particular need a radical overhaul.

Laws establishing collective agreements on working conditions and area-wide wage agreements not only hamper productivity and growth by disregarding geographic disparities and the size of companies, they also increase the cost of labor in an often disproportionate manner. Wage agreements should be concluded between the workers or workers' representatives and the respective company, not on an all-inclusive basis for an entire industry. Only then will personal commitment and performance pay off for the individual.

The 1970s model of representation based on parity can be used as a point of departure. Likewise, a reform of the German trade unions is urgently needed. This reform must not abolish or generally weaken organized labor, but rather realign the influence of the umbrella organizations (DGB, IG-BCE, and others) on local unions so that the umbrella organization does not stand in the way of the will of the local workers. As is the case in the overall political structure, the principle of subsidiarity should apply in this area. Too often, the union head organizations are more concerned with expanding their own and personal political power than with the interests of the local labor unions.

The German labor market and the German economy are suffering from a structural "malaise" - and its effects have been showing especially in the past few years. Without an intellectual turnaround among the responsible parties and a return to basic liberal structures of the economic order as defined by Ludwig Erhard, we will not overcome, let alone rebound from the slump in the German labor market.

Nico Wirtz is a Research Fellow with the Friedrich Naumann Foundation.


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