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The Failure of the Social Market

August 19, 2003

Wilhelm Roepke is often credited as the theoretical architect of Germany's postwar "miracle." Few know that he was actually quite critical of the postwar system's compromises with state intervention. In fact, in 1960, he wrote that the contrast between the productive market and "continuous redistribution of income for the sake of equality" is "intolerable in the long run."

The "social market economy" of Ludwig Erhard's Germany has failed. Sixty years after its inception, the economic system that led West Germany out of the pestilence and destruction of wartime planning has finally revealed the inherent weakness of its foundation. It failed because a Bismarckian welfare state cannot be fused with capitalist market order. Roepke's words over forty years ago were as prescient as they were ignored.

As the Germany of today nears a zero growth rate and a staggering burden from its welfare obligations, German politicians entertain a host of measures in an attempt to revitalize the world's third largest economy. Yet so long as the welfare state remains intact, Roepke's "intolerable contrast" threatens to destroy this once great economy.

Germany's current predicament is instructive in two ways.

First, it illustrates that a "third way," albeit one that leans towards markets, will ultimately trend towards welfare-socialism. While some may argue that the post-war Federal Republic of Germany, under the stewardship of Erhard was not "third way," one needs only look at the name Erhard bestowed upon his reconstruction project, the "social market economy." It was a system that valued the resource allocating ability of a market economy, but relied heavily upon the perceived social benevolence of the State.  

Second, the welfare state, if taken to its logical conclusions, is unsustainable. Much like the booms and busts of a Fed induced credit expansion, increased welfarism dwindles resources and ultimately "busts." As more and more of the German population is seduced by the welfare Siren, torpor gradually replaces the dynamism of capitalist production.

Due to the gradual increase of income transfers and economic regulations, the new, post-unification Germany increasingly resembles the former East Germany. The German unemployment rate now hovers around 10%, with over 4 million citizens out of work. The country's economy has even been compared to stagnant Japan, the laughing stock of industrial economies. Growth forecasts for this year have recently been downgraded to 1%, with Germany ranking last in GDP growth for all E.U. countries for the past 3 years. All in all, Europe's mightiest economy is on track to fade from the economic spotlight and take much of the continent down with it.

For years, Europeans have criticized the American "hire and fire" system of capitalism. Yet it is that seemingly disinterested dynamism that gives America its economic strength and the lack of which that imperils the German economy. Despite a slump in economic growth that threatens the prosperity of all Germans, however, the labor unions, politicians and welfare recipients have remained obdurate to reform. As reported in the Financial Times of London, a poll conducted by the Allensbach opinion research institute found that 38% of respondents look at reforms of the welfare state with fear. Another 31% look upon reforms with skepticism.  

Reality is slowly requiring entrenched interests to look anew upon moderate measures that were once loathed and decried. Chancellor Gerhard Schroeder unveiled a plan to reduce the top marginal tax rate to 42% from 48.5% and the bottom rate to 15% from 19.9%. Schroeder's minister of labor and economics, Wolfgang Clement, promulgated a proposal on March 14 of this year to allow small businesses to fire employees more freely. Even senior Catholic Church officials described the German labor unions as "unbelievably rigid" and called on them to lower their demands on wages in order to allow more job creation. While these requests for reform may seem timid, they indicate an incipient dialogue occurring in Germany that would not have been conceivable even a few years ago.  

For SAP AG, a German software manufacturer, the litany of regulations pertaining to layoffs, health care, severance pay and other government mandates is increasingly putting the software giant, the world's third largest, at the mercy of global competition. Attempting to compete with firms here in America and elsewhere, where "dog-eat-dog" capitalism has allowed firms to trim workforces, the company's executives lament their inability to control costs.

"At the moment, SAP is just not as flexible as the competition," says the company's co-chief executive Henning Kagermann, as quoted in the Wall Street Journal. Auto giant and German stalwart Volkswagen recently negotiated a deal with its union to limit pay, increase flexibility with its workers and tie pay to performance. Yet this is a small success story among countless failures.

The roots of this current crisis date back to the late 1940's, when Ludwig Erhard, former Chancellor and Minister of Economics for the Federal Republic of Germany, instituted his "social market economy." The term was coined by economist and Erhard confidant Alfred Muller-Armack and came to symbolize a belief in the market, albeit one circumscribed by government regulation and a strong welfare system. Erhard's system is still today widely credited with the creation of the German "economic miracle."

To be sure, much of Erhard's economic policies helped to transform a war-torn Germany into a dynamic capitalist power. To read the speeches and writings of Erhard is to find many quotable gems. For example:

"A glance at the economic system and methods of totalitarian states—of the Soviet bloc, for example—is enough to show that state-ownership of the means of production does not lead to an increase of wealth for the people but, on the contrary, to their exploitation, whereas the reverse is true of the free countries and peoples, which are denounced for their so-called capitalism but which clearly illustrates how private ownership of the means of production is contributing more and more to the general welfare."

But Erhard also viewed a laissez-faire economy with great suspicion. To him, it led to unremitting greed and mammonism. Thus a strong welfare system coupled with comprehensive workers rights was needed to offset the "excesses" of the market economy. "All steps capable of contributing to a fair distribution of the national product, and with it of the national income, deserve our most careful consideration," wrote Erhard whilst wearing his socialist hat.

In a January, 2003 commentary appearing in the Financial Times of London, professor Norman Barry opined, "the social market advocates were too relaxed; they believed the new order would produce enlightened people who would not need market incentives to behave responsibly. How wrong they were. Germans are normal, rational people. They will not work unless they have to. Now it often pays not to get a job and it is rational to stay in education until you are 30." Unless chained to reality by the forces of the market, the people and politicians have been free to bloat and expand the welfare state of Germany.

Yet just as booms ultimately turn into busts, Germany must now reckon with the rot and indolence that is a government managed economy. Instead of harking back to the teachings of Erhard, German's would do better to read the works of another Teutonic sage, Wilhelm Roepke: "If government organized mass relief is the crutch of a society crippled by proletarianism and enmassment, then we should direct all our efforts to being able to do without this crutch. This is true progress, from whatever point of view we look at it. It can be measured by our success on steadily widening the area of individual and voluntary group providence at the expense of compulsory public providence."


Jude Blanchette, a recent graduate of Loyola College, writes from Vermont. He can be reached at  jblanchette1@hotmail.com. See other articles by him.


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