The German Social market economy

I've spent the entire last week in Germany, as a part of a delegation of Croatian economists and economic experts, organized by the Konrad Adenauer Stiftung (KAS). The idea was to visit the main economic and political institutions in Germany and open a dialogue on the problems facing Croatia, but primarily to learn about the experiences of the German solutions/responses to the crisis through the conceptual framework of their Social market economy (i.e. the German ordoliberalism). We have visited a series of institutions, starting with the Bundesbank and the ECB in Frankfurt, and ending with the Ministries of Finance, Economy and Energy, Labour and Social Affairs, and even the Office of the Chancellor, all in Berlin. In the middle we visited a series of other noteworthy institutions like BaFin (the regulator of financial services), the Council of Economic Experts, DIW institute, the banking association, a few members of parliament and so on. I plan to write a separate post on some of the main outtakes of the trip, with emphasis on how the Germans see their role in Eurozone, opposed to how the rest of Europe sees it. And rightly so. Before I descend into commenting the actual state of the German economy, I would like to extend a few thoughts on their "unique" idea of the so-called Social market economy. 

But first a little bit about the trip initiators and organizers, the Konrad Adenauer Stiftung. KAS is a political foundation (stiftung means foundation), associated with but independent of the German center-right party CDU which currently holds power in Germany. The idea of the Stiftung is to promote the ideas of freedom, liberty, peace and justice, democratic consolidation, and development, mainly through their civic education programs, but also to provide a basis for political action, all around the world. A similar institution to KAS is a foundation called Friedrich Ebert Stiftung (FES) aligned with the social democratic SPD. Both of these political foundations act as a sort of a shadow embassy outside of Germany, that connect their own parties (parties they're aligned with) with the opposition and in-office party of the country they reside in. In addition to this role, they both act to promote the civil society. KAS has offices in more than 120 countries worldwide, and thus serves a foreign policy role as well. For example they had an important role in the reconciliation and partnership between Germany and Israel, a relationship previously rebuilt by the Chancellor whose name the foundation carries - Konrad Adenauer. Rebuilding this relationship was crucial for Germany after WWII, and was the final step towards designing a new German society, one based on strong institutions, competition and democracy. Or in other words - ordoliberalism. 

Social Market Economy

So what is the Social market economy (in German: Soziale Marktwirtschaft)? According to the prevalent German interpretation it represents a type of market capitalism combined with policies promoting social insurance (protection for the poor, unemployed, health benefits, etc.). It is based on the idea that markets must be in the center, coordinating the economy (prices), while market participants must be constrained by strong and enforceable institutional rules. It is a system based on competition, order, and most of all on setting a clear institutional framework in which the market actors must participate.

Germans are proud of this model, introduced by the great Ludwig Erhard (pictured) back in 1949, who was then a Minister of the Economy, under Chancellor Konrad Adenauer. Erhard was the Economy minister for the entire duration of Adenauer's Chancellorship (14 years, from 1949 to 1963), and succeeded him as the next Chancellor from 1963 to 1966. He is widely lauded as the creator of the Social market economy, presented at the time as the compromising "Third way", something between the laissez faire Anglo-Saxon liberal capitalism (which was still, in the mind of the Germans, to blame for the Great Depression of the 1930s), and the communist central planning system (introduced during the Weimar Republic and fully applied during National Socialism). Germany needed something new at the time, an idea that transcends the fallen ideologies of the past. It needed, for the first time in its history, to apply a truly capitalist, market democracy.

That's why the model was so successful. From 1949, Germany, for the first time in its history, has introduced a democratic system with a market economy. The term most usually related to Erhard and this initial period of German democratic consolidation is the German economic miracle, which has in the 1960s and 1970s crated an economic powerhouse that Germany is today. It didn't start without problems however. In the begining, after the destruction of the Second World War, Germany was under occupation and under price controls and rationing. Housing was destroyed, industrial production as well, food production halved, inflation was an open threat yet again, and a lot of male population died in the war. The task seemed impossible, particularly due to the country being split in half and the animosity arising among its occupiers. But Erhard was stubborn enough to push through his reform despite the fact that many opposed it at the time. Even the allies weren't sure of his ideas. But he abolished the price controls and rationing of food, he limited monopoly power by introducing antitrust laws, reduced marginal tax rates (from 95% to 18% marginal rate), introduced a new currency reform to bring back price stability (and eventually turn the German Mark into the strongest currency in Europe). All the reforms came as an initial shocks, particularly the contraction of the money supply, but the stage was set for Germany to take flight. Literary overnight the country came to life. 

One might ask how is this economic model any different from the one applied in most of Europe today? A market economy with a welfare state - that's what Europe basically is. Some are more successful at it (Germany, Scandinavia, even the UK), while some are less (France, Italy, Spain) - relatively speaking. Who is to say the UK isn't based on the very same principles, even during the Thatcher era? A strong market-based economy, which has a notable social category. The difference here is not so much Germany vs rest of Europe, as it is Germany vs the United States. However the difference here is also in the margins. The US has something called cut-throat capitalism which fosters huge innovation and a keen trial and error process, while Germany (as well as the rest of Europe) has cuddly capitalism, which also innovates but to a lesser extent primarily due to a more lenient trial and error process. (These terms are used by Daron Acemoglu in a very interesting paper he co-authored with Robinson and Verdier, and which raised quite a discussion back when it's working paper version was published).  In Germany for example if you start a business and fail once, you don't dare repeating the same mistake again. In the US it is quite common to start over 4 or 5 times before finding the right recipe for success. After all Merkel recently expressed concern that there is no German Google or German Facebook. There is a reason why this is so, and why those kind of companies originate in the US, not in Europe. Which is not to say one system is better than the other. Both have their strengths, but both have weaknesses as well. The US exhibits higher levels of inequality because of this (even if we look at it historically), but due to its entrepreneurial spirit it has a much shorter time span for recovery and a much quicker response time than Europe. 

Overall, the German success is a unique story, but it's not a unique economic system. It is a market democracy with strong institutions. As easy as this sounds, for many countries there's still a long way to achieve it.