SOCIAL MARKET ECONOMY the Principles Behind Germany’S Economic Success

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SOCIAL MARKET ECONOMY The principles behind Germany’s economic success

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Publisher 1 ORDOLIBERALISM��4 Friedrich-Naumann-Stiftung für die Freiheit Developed during the 1930s, ordoliberalism is Germany´s most Truman-Haus prominent liberal theory and the theoretical groundwork for the Karl-Marx-Straße 2 Social Market Economy. 14482 Potsdam-Babelsberg 2 ETHICAL AND INTELLECTUAL /freiheit.org FOUNDATIONS ��6 /FriedrichNaumannStiftungFreiheit The ordoliberals drew on classical-liberal ideas developed /FNFreiheit by Adam Smith and tried to overcome the weak points of laissez-faire liberalism. Author Justus Lenz, Policy Advisor Economics and Finance 3 SOCIAL MARKET ECONOMY ��8 Based on the main pillars freedom, competition, and the rule of law, Editor the Social Market Economy provides the framework for Germany`s Liberal Institute – Friedrich Naumann Foundation for Freedom economic success. Justus Lenz, Policy Advisor Economics and Finance 4 FAMILY BUSINESSES AND Production HIDDEN CHAMPIONS ��12 Luise Bofinger, Friedrich Naumann Foundation for Freedom Small and medium-sized enterprises and family-owned businesses are the backbone of Germany´s economy and thrive in Contact the Social Market Economy. Telefon +49 30 220126-34 Telefax +49 30 690881-02 5 SOCIAL MARKET ECONOMY E-Mail [email protected] IN THE 21ST CENTURY ��14 Applying the Social Market Economy`s guiding principles can help As of formulate good policy responses to our most pressing challenge May 2021 including globalization, environmental protection, and the digital transformation. Notes on using this publication This publication is an information service of the Friedrich Naumann Foundation for Freedom. The publication is available free of charge and not for sale. It may not be used by parties or election workers during the purpose of election campaigning (Bundestags-, regional and local elections and elections to the European Parliament). 4 Ordoliberalism 5

1 Ordoliberalism

Starting in the 1930s, a group of thinkers around Walter Eucken and Franz Böhm, an economist and a lawyer at the University of Freiburg, developed a new school of thought called “ordoliberalism”. Having just experienced the Great Depression and facing the rise of commu- nism and fascism, they focused on reforming the existing capitalist order. Without institutional backguards, they feared, some market actors can accumulate too much power. Adam Smith, the founder of modern economics, already knew that entrepreneurs have strong in- centives to restrict competition. Eucken and Böhm argued that these developments had a severe negative impact on consumers, e. g. higher prices, and on competitors who were pushed out business. They also feared that the accumulation of power can threaten democracy WALTER EUCKEN itself. To preserve free competition, the ordoliberals emphasized the FRANZ BÖHM need for institutions charged with protecting free markets. Source: by courtesy of publishing Source: Walter Eucken Institut company Mohr Siebeck, Tübingen Development of the Social Market Economy Recommended further reading: In contrast to the proponents of laissez-faire capitalism and to those of a centrally planned economy, ordoliberals see the importance B Dold, M., Krieger, T. 2020. Ordoliberalism and European Economic Policy: of state, market, and society. They believe that these orders are Between Realpolitik and Economic Utopia. Abingdon: Routledge. interdependent and are all vital for a free society. Based on these B Eucken, W. 1950/1992. The Foundations of Economics: ideas, Eucken and other thinkers worked on a new economic order History and Theory in the Analysis of Economic Reality. for the time after World War II. Their work became the foundation of Berlin: Springer-Verlag. the Social Market Economy, which was implemented by the liberal B politician Ludwig Erhard. Ordoliberalism as such never gained much Goldschmidt, N. & Wohlgemuth, M. 2008. Social Market Economy: traction outside Germany, even though its ideas on anti-trust legisla- Origins, Meanings and Interpretations. tion were formative for the process of European Integration. Nonet- Constitutional Political Economy 19 (3), p. 261–276. heless, ordoliberalism can be placed into a wider intellectual context B Kolev, S., Goldschmidt, N. & Hesse, J.-O. 2020. Debating liberalism: of constitutional and institutional economic research programs. For Walter Eucken, F. A. Hayek and the early history oft he Mont Pèlerin Society. instance, there are striking similiarities between ordoliberal ideas The Review of Austrian Economics 4/2020, p. 433-463. and the works of James Buchanan or Elinor Ostrom. Some scholars B also argue that the Austrian economist Friedrich August von Hayek Reinhoudt, J. & Audier, S. 2018. The Walter Lippmann Colloquium: was strongly influenced by ordoliberalism. The Birth of Neo-Liberalism. Cham: Palgrave Macmillian. B Vanberg, V. J. 2004. The Freiburg School: Walter Eucken and Ordoliberalism. Freiburg Discussion Papers on Constitutional Economics 04/11, Freiburg. 6 Ethical and intellectual foundations 7

2 Ethical and intellectual Timeline: Development of Ordoliberalism 1900 foundations 1918 End of World War I In developing their ideas, the ordoliberals drew on well-established liberal conceptions developed in the 18th century. Many of their basic assumptions were already part of Adam Smith´s work, the Scottish 1930s moral philosopher who founded modern economics. Examples are Eucken, Böhm and others the eminent tendency of market actors to restrict free competition or develop the basic ideas of Ordoliberalism in Freiburg 1910 the insight that the economic, political and moral order of a society are interconnected. One might argue that the ordoliberals drew on crucial elements of Adam Smith´s thinking which were ignored by (some) laissez-faire economist in the 19th century. But Smith was certainly not the only source of inspiration for the ordoliberals. The development of ordoliberalisms was also part of wider reform movement. 1938 – 1944 1920 Ordoliberals meet in the Walter Lippmann Colloquium secret Freiburg Circle to discuss a new political Facing the failures of both laissez-faire capitalism and totalitaria- and economic order for a nism, a group of thinkers met 1938 in Paris with the goal to renew post war Germany 1938 liberalism. This Walter Lippmann Colloquium, was attend by philos- Walter Lippmann Colloquium in Paris phers, political scientists, economists and businessmen from Europe 1930 and the United States. Here the term “neoliberalism” was coined, to define a new liberal program in contrast to laissez-faire liberalism. While the ideas of the participants varied, they all feard the failure of liberal democracies. And in contrast to a common misconceptions of “neoliberalism”, the general agreement was that states play a crucial role in establishing and maintaining free markets. Eucken and Böhm did not attend. But Wilhelm Röpke and Alexander Rüstow who later helped to implement the Social Market Economy in Germany 1940 were part of the meeting in Paris, as well as Hayek. The Lippmann Colloquium shows that ordoliberal thinking about the interconnected nature of markets and states institutions was internationally wide- 1944 spread. Scholars in England, the USA and France also emphasized After the failed assassination of the importance of a competitive order (like the Social Market Eco- Hitler members of the Freiburg circle nomy) for well-functioning markets and free societies. England, the 1945 were interrogated, some arrested USA and France also emphasized the importance of a competitive and tortured order (like the Social Market Economy) for well-functioning markets End of the World War II 1950 and free societies. 8 Social Market Economy 9 How does the social 3 Social Market Economy market economy work?

Companies compete Germany´s swift economic recovery after World War II looked like in the market, the state a “miracle”. Yet, it was based on implementing an economic order acts as a referee that allowed entrepreneurs, innovators and workers the freedom to achieve their best. It guaranteed the rule of law and a high degree of political predictability and stability. This economic order, the Social Market Economy, was based on the ordoliberal idea that govern- ments and markets both have essential roles to play in a modern, open society. The state sets general rules, oversees and enforces state ensures a fair level playing field them. Within these rules, everybody is free to compete without state intervention. Therefore the state acts as a referee, observing the game and enforcing its rules, while abstaining from participating in the moves of the game. market framework Policies

West Germany significantly outperformed East Germany, where a

communist government implemented a centrally planned economy. RULES monopolies and Freedom, private property, competition and the rule of law proved to - private property oligopolies are forbidden - rule of law be more successful than an all-controlling bureaucracy. Yet, state - anti-trust legislation institutions did play vital roles in West Germany´s economic system. - price stability ... For example, the Bundeskartellamt, the anti-trust authority, was founded in 1958 to safeguard free competition against cartels and is set by the state other abusive practices. Another crucial institution was the Deutsche Bundesbank, the independent central bank, whose only goal was to preserve price stability. This monetary policy proved to be very effective for fostering long-term economic growth. Infrastructure and a quality-oriented public education system are further examples, as well as a social security system. The creators of the Social Market Economy believed that free markets are the most important part of social policy, as competition guarentees fairly-priced quality pro- ducts as well as fair wages. This did not negate the need for additional social policies such as unemployment insurance. Nonetheless,

all social policy programs were to be implemented in a form that did Freepik - macrovector Graphics: not hinder competition.

private companies bear chance of winning and risk of losing 10GERMANY‘SSocial Market ECONOMIC Economy RECOVERY 11 Development of unemployment rates before 1995 only West Germany

12 11,7 Germany’s 11

economic recovery 9,7 10 9,4

Development of purchasing power 8,2 Innovation and higher productivity allow a good standard of living doing less work. 8 7,7 Average working hours which have to be worked to purchase consumer goods in West Germany. 6,4 6,4 5,6 R 6 5

S 4 BUTTER 4 3,3 250 g 1 kg 0,5 l PAST (1960) 347 HOURS 221 HOURS 154 HOURS 39 MINUTES 30 MINUTES 15 MINUTES 2 1,3 0,7 0,6 NOW 21 HOURS 21 HOURS 17 HOURS 6 MINUTES 3 MINUTES 3 MINUTES (2017) 0 1955 1955 1955 1955 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2019

Source: Deutsche Bundesbank Social Market Economy Timeline

US Marshall plan for the reconstruction Ludwig Erhard Development of the social benefit ratio Price liberalization act, appointed of Western Europe guiding principles Minister of Share of government social expenditure in gross domestic product (social benefit ratio) in percent. announced bill passed Economic Affairs From 1991 onwards including East Germany. 29,9 30,3 30 28,8 28,9 29,2 Bank of German Federal Republic Act against Restraints 27,6 States founded of Germany of Competition (“GWB”) 26,3 25,7 by the Allied powers founded passed 25,2 25 24,1

05 23 01 02 18 21 23 24 20 25 03 01 20,2 June July March March June June May June Sept March July Aug 19,4 1947 1947 1948 1948 1948 1948 1949 1949 1949 1957 1957 1957 20 18,3

Special Unit on Money Currency reform: Treaty of Rome 15 and Credit under the Deutschmark establishing the chairmanship of Ludwig introduced European Economic Erhard established Community

10 Ludwig Erhard becomes First draft of an German Central Bank 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2019 director of the Economic anti-cartel law (“Bundesbank”) Council of the Combined (“Josten draft”) established Economic Area Source: Bundesministerium für Arbeit und Soziales 12 Family businesses and hidden champions 13

4 Family businesses and Family businesses in Germany hidden champions 58%

Family businesses play an essential role in Germany´s economy. Regarded as the backbone of Germany´s economic success, their 90% defining characteristic is the controlling interest of one family, sometimes of only one or two members, sometimes of many hundreds. While most family businesses are small or medium-sized, some are Employees in family owned businesses (percentage of all employees in businesses*) multibillion-dollar companies. Irrespective of their size, they often belong to the most innovative companies. Some of these smaller companies are only known to experts, even though they are world Share of family owned businesses wide leaders in their market segment. Over 1300 of these companies (percentage of all active businesses*) – often termed “hidden champions” – exist in Germany. Family businesses are very popular employers, not least because many embody the spirit of the Social Market Economy. They combine a competitive nature and a drive for freedom with a strong sense of responsibility. Usually, especially in rural areas, they are deeply intertwined with their regional communities. 52% Framework for successful companies

Family business in Germany did not grow despite open and highly competitive markets – they are successful because of the ongo- Turnover of family businesses ing competitive pressure to improve and adapt. Free markets and (percentage of total turnover*) competition were key factors for the formation of smaller “hidden champions” because existing larger companies could not resort to unfair practices or cartels to hinder fledgeling new competitors. Yet, in order to be successful, family businesses need an internationally competitive framework consisting of the rule of law, good infrastructure and reliable state institutions. Family businesses are especially hard hit by unfavorable conditions such as excessive taxes or bad infrastructure since they tend to be very interconnected with their region. A critical factor for thriving family businesses is, of course,

the inheritance tax system. A high inheritance tax is a prohibitive Freepik - macrovector Graphics: factor for the development of intergenerational family businesses and economic sustainability. * state controlled companies excluded Source: ZEW, Stiftung Familienunternehmen 2019 14 Social Market Economy in the 21st century 15

5 Social Market Economy Carbon dioxide trading scheme explained limit of total CO emissions in the 21st century “Cap” 2

The Social Market Economy, as implemented in Germany, included a stronger degree of social policy and state intervention than intended by Eucken and his peers. This is an ongoing challenge. Too many revenue interventions and too many ill-managed social spending programs CO2 threaten both the functionality of freedom and of competition. In a Social Market Economy, the state needs to be strong in order to “Trade” between ermitters results in a uphold the rule of law, but it also needs to resist the temptation of market price for emission rights direct market interventions, even though they can be widely popular (one example is the rescue of prominent/important businesses in trouble). This becomes more urgent in the 21st century because protectionism and nationalism are again on the rise. In addition, so- b cieties worldwide face pressing challenges such as climate change and digital transformation with increasing monopolistic structures of company A sells unused company B buys large platforms. unused emission rights emission rights additional emission rights

Ideas for the future of the Social Market Economy Source: Liberales Institut

The basic principles of the Social Market Economy can be helpful Fiber glass connections in percentage of all broadband guidelines for dealing with these challenges. For example, updating connections in selected countries existing rules to be compatible with digital technologies or providing state of the art fibre connections are important parts of a modern South Korea 80.4 market framework. Tackling climate change through direct interven- Sweden 66.9 tions, e. g. by banning traditional light bulbs, did not deliver sound results. Introducing a carbon dioxide trading scheme is an efficient Spain 57.5 alternative. It could help harness the innovative potential of competi- Poland 20.5 tion to deliver better CO2 reduction results. As our economies and societies become more interconnected, we also need to start thinking Switzerland 18.8 about global sets of rules for transnational problems such as climate change. Developing the existing carbon dioxide trade systems into France 16.5 a global system might be the key to solving this problem. Adapting USA 14.3 regulation and antitrust legislation to the platform economy will also be crucial for conserving competitive markets. In many ways, Germany 3.2 the 21st century will need a global market framework, at least for Austria 2.5 specific areas. UK 1.9 Source: OECD 2019