Origins and essence of a socially-oriented market economy

Questions “Where are we going?” “What are we moving to?” are no longer perceived as painfully as before, since the main answer is known: “to a socially-oriented market economy.” However, in the wake of this answer, new questions arise: Where are the origins of the new economy? Who, where and when put forward such ideas? What’s their point? How and to what extent are they justified? Are they proven in practice?

Any economy, by definition, is social. But at the same time, a social market economy is understood as a very specific type of economic system that arose and strengthened in the postwar decades in industrial countries , mainly in Western Europe, and is characterized by an exceptionally high level of social and economic well-being of citizens. Western European countries call themselves welfare states and implement social policy not only at the national level, but also at the supranational level – within the framework of the European Union.

The social market economy as a special type of economic system is characterized not only by a high level of well-being of the population. It is distinguished by a system of socio-economic institutions that direct the functioning of all elements of this system to the realization of the goals of social justice, security, high level and quality of life.

Therefore, in our opinion, it is important to distinguish economies with a high standard of living and significant social spending from the actual social market economies. The first are usually liberal societies that have achieved a high level of material wealth and therefore can afford to allocate huge funds to help the poor, to finance health, education and other social goals. The most obvious illustration of such societies is the United States and Canada. However, these countries do not have sufficiently powerful “built-in” mechanisms for harmonizing interests between social groups. On the contrary, small Western European countries, for example: Austria, Belgium and Switzerland, can be classified as “social economies” precisely on the grounds that their socio-economic and legal systems are “tuned” to achieve social harmony and a high standard of living for the bulk of the population, although in absolute terms of income and quality of life they are inferior to the leading market economies.

At the beginning of the XX century in the United States and Germany, in the wake of antitrust, antitrust policy, a new scientific direction arose, which is now called socio-institutional. Its brightest representatives were the academic economists Thorstein Veblen and Wesley Mitchell. By this time, the U.S. had become the richest country in the world with  a monopolized economy. Therefore, the first antitrust laws and measures appeared here.

The new direction stubbornly proved the imperfection of the dominant market monopolized economy. It required a broader, more comprehensive approach to economic problems, taking into account the strong impact of social institutions and processes on the economy. These included the state, law, trade unions, morals, religion, etc. Supporters of the new direction demanded social control over an imperfect monopoly market.

Already in this scientific direction it is possible to see the origins of a new, social model of the economy. After all, it was economists – “institutionalists” who drew attention and emphasized that there is no longer a “clean economy”, that, together with material ones, such factors as legal, social, moral influence the economy. And all of them affect the economic growth and well-being of the country. Such a broader approach to the economy, taking into account its direct connection and dependence on the social sphere and its problems, is recognized in history as an achievement of the methodology and theory of economics.

However, the very new concept of “social market economy” matured later, in the field of German history. Even before the war unleashed by Nazi Germany, under the great impression of the world economic crisis that broke out in the 30s, a number of German economists were unanimous in the fact that in the future their country should distance itself from the outdated principles of a free market economy responsible for the world crisis and unrest. Their names are Walter Eucken, Wilhelm Röpke, Leopold Miksch.

The theoretical foundations of the social market economy go back to the pre-war works of scientists of the Freiburg school – W. Eucken, F. Böhm and others, who developed the concept of “orders”. This scientific direction is called ordoliberalism. The main concept of this theory – “order” – is defined as a set of institutions and norms associated with economic organizations and types of economic behavior (not all of which are of an economic nature) and regulating relations between the elements of the national economy. It is easy to see that the concept of “order” is close to the concept of “rules of the game” common in modern Anglo-Saxon literature, which economic entities adhere to in their functioning and interaction. A great merit of the ordoliberal school was the study of the relationship between the economic order itself and political, state and legal orders.

Ordoliberalism thus attempted to create an integral picture of an economic system functioning in an inseparable unity of economic and non-economic institutions. Such an approach is fundamentally different from the neoclassical tradition, which, as you know, sees the subject of economic science in the study of the interaction of maximizing subjects in the process of production and distribution of limited (economic) goods. Political and legal analysis of economic processes allowed V. Euken and his followers to develop a classification of “economic orders” from a purely market to a centrally controlled model and to study the nature and methods of coordination between subjects.

In post-war destroyed Germany, the question arises with renewed vigor: which way to go? Distancing themselves now from the authoritarian-regulated economy, the Germans are looking for a 3rd way. The formula for this path was put forward by the German economist Alfred Müller-Armack (1901-1978). It consisted of 3 words: social market economy. In this formula for germany’s future, the idea of combining the principles of the market and social equalization was laid. The basic philosophy of a social market economy is the interaction of the market mechanism and the “socially concerned” or “petitioning state”.

Proponents of the theory of social market economy quite fruitfully used the ideas of ordoliberalism in terms of understanding the integrated approach to the functioning of the economy as part of a broader socio-economic and state-political system. At the same time, there are significant disagreements between the supporters of these theories. They concern the understanding of the role of the state, especially at the stage of the post-war reconstruction of the German economy: the concept of a social market economy insisted on a more active and direct participation of the state in economic life. Since 1948, these ideas have acquired the status of a state doctrine, the implementation of which was headed by Professor, Federal Chancellor of the Federal Republic of Germany Ludwig Erhard. The implementation of such a doctrine was later called an “economic miracle”.

Thus, the idea of a social market economy is based, according to Müller-Armack, on a combination of two components: a market economy and social justice. His argument about the new path – the social market economy – covered five main areas.

First, the argument was sharp criticism of centrally managed economies, including total in Germany.

Second, a carefully formulated critique of capitalism (the market) of free competition.

Thirdly, the allocation of the market mechanism as a special managing tool.

Fourth, the rationale for the importance of the social component in the economy and the need for “socially motivated interventions” in it.

Fifth, the identification of certain areas where the automatism of the market does not provide the results necessary for society. Such areas are price, structural (including production and regional aspects), housing, social, monetary.

Theoretical ideas of economic order are translated into reality as they correspond to objective conditions and interests. It is impossible not to note the important role of political forces and power.

The turn to a new economy began in Germany amid a brutal 3-year crisis with the monetary reform of 1948. It is important that the mass of new money corresponded to the previously accumulated mass of goods. This was (according to L. Erhard) a necessary prerequisite for the release of prices.

The strategy of economic policy to create a new economy was at this time to revive market pricing, profit growth (excluding speculative) and the ability of enterprises to invest. At the same time, control was maintained (according to L. Erhard) over prices for vital food products, as well as for oil, gasoline, transport and mineral fertilizers.

The Federal Republic of Germany, as you know, received until 1952 the 1.56 billion US dollars allocated under the Marshall Plan, which, we emphasize this, went to the leading industries. By 1960, Germany’s economic success was already so great that they began to talk about an economic miracle.

Nevertheless, the consideration of the theory of ordoliberalism as the conceptual basis of the economic system of the Federal Republic of Germany and German economic practice makes it possible to distinguish between the concept of a social market economy and another Western European economic model, which until recently claimed to be a “third way theory” – Scandinavian, or Swedish. In its most general form, it boils down to the following. The German model is basically a market model. It is based on the ideas of inclusive competition and the contractual nature of wage fixing and other leading socio-economic parameters. The Swedish model is a social democratic model that assigns the state the place of the supreme socio-economic force. The democratically elected state power is delegated enormous powers to regulate socio-economic life. However, it is impossible not to recognize that the conceptual differences between the social market economy and “Scandinavian socialism” are blurred in practice. All modern Western European “social economies” are based on the interpenetration of market and state principles, as well as on social solidarity (social partnership).

In the German economic model, the state does not set economic goals – this lies in the plane of individual market decisions – but creates reliable legal and social framework conditions for the implementation of economic initiative. Such framework conditions are embodied in civil society and the social equality of individuals (equality of rights, starting opportunities and legal protection). They actually consist of two main parts: civil and economic law, on the one hand, and a system of measures to maintain a competitive environment, on the other. The most important task of the state is to ensure a balance between market efficiency and social justice. The interpretation of the state as a source and defender of legal norms governing economic activity and competitive conditions does not go beyond the Western economic tradition. But the understanding of the state in the German model and, in general, in the concept of a social market economy differs from the understanding of the state in other market models in the idea of more active state intervention in the economy.

The German model, which combines the market with a high degree of state interventionism, is characterized by the following features:

individual freedom as a condition for the functioning of market mechanisms and decentralized decision-making. In turn, this condition is ensured by an active state policy of maintaining competition; social equality. The market distribution of income is determined by the amount of capital invested or the amount of individual effort, while achieving relative equality requires vigorous social policies. Social policy relies on the search for compromises between groups with opposing interests, as well as on the direct participation of the state in the provision of social benefits, for example, in housing construction; anticyclical regulation; stimulating technological and organizational innovation; and the implementation of structural policies.

The listed features of the German model are derived from its fundamental principles of the social market economy, the first of which is the organic unity of the market and the state. This combination of two principles, which for most of economic history have been mutually antagonistic, first developed only in recent decades in Western Europe.

The expansion of the functions of the state in modern society while preserving market freedoms, institutions and mechanisms is to a decisive extent due to the increased complexity of the socio-economic process. Many of the fundamental problems of today’s society cannot be effectively solved by market mechanisms alone. This is, first of all, the strengthening of the social sphere, which has become one of the most important factors of economic growth. Thus, the level of education, the qualification of the labor force and the state of scientific research directly affect the pace and quality of economic growth, which is confirmed by econometric calculations. Health, social security and the environment have a huge impact on the quality of the workforce, on economic development in general. The market alone cannot create a powerful social sphere, although market mechanisms, especially competition, may have a strong social orientation. In economic theory, as you know, the possibilities of manifestation of social effects in conditions of perfect competition are considered, but real life introduces too many “obstacles” and does not allow these effects to manifest themselves.

A special factor in the objective increase in the role of the state is the “institutional rigidity” characteristic of modern societies – the presence of social and economic mechanisms that allow the change of fundamental market variables in only one direction and prevent changes in the opposite direction. For example, the absolute level of prices and wages usually increases, and when there is a decline in the business situation, it is extremely difficult for any entrepreneur to reduce prices and wages, to dismiss some of the employees. The modern economy has largely lost the flexibility that was inherent in early capitalism.

But, of course, it would be a mistake to see state regulation as a panacea for all socio-economic problems. Just as there are “market failures,” there are “state failures.” Economic efficiency is primarily the market. All modern developed economies rely on market principles, which are gradually perceived by the rest of the world, although each country retains national specifics.

The former opposition between the state and the market in developed countries has lost its meaning: both the state and the market occupy a well-defined place in the socio-economic system, perform functions inherent only to them and exist in inseparable unity. In the model of a social market economy, apparently, a successful combination of the state and the market has been found in the form of active state intervention in the economy, primarily in the social sphere, with unconditional observance of the fundamental principles of a market economy.

In the model of a social market economy, great importance is attached to maintaining a competitive environment. Protection of competition can be considered as the second fundamental principle of the concept of a social market economy. In order to maintain a competitive environment in the Federal Republic of Germany, numerous and extremely detailed laws have been developed, which is generally characteristic of the German system of state economic management. Protection of competition is one of the central functions of the state in the German model, largely determining the ways of state intervention in economic life: the market system can easily lose its competitive character if it is not supported by an exogenous non-market force.

In practice, the competitive mechanism does not always work smoothly. There are many monopolistic associations, especially the cartel type typical of the German economy, and many of them are in fact under the protection of the state. Conceptually, however, the very question of the relationship between competition and social welfare deserves attention, which is manifested in the following:

competition ensures the most efficient functioning of the market mechanism and thereby contributes to the maximization of social wealth; competition establishes a correspondence between income and inputs of factors of production, including between wages and labor costs, and thus supports social justice; competition limits the growth of prices and ensures the availability of goods and services for the bulk of the population.

The third principle of the German social market economy is social partnership. Today it is becoming one of the leading principles of the organization of socio-economic systems. The idea of a patient and persistent search for a compromise between social groups objectively predisposed to confrontation reflects the high level of development of society in general and its political culture in particular. Social partnership is a kind of escalation of market relations beyond the boundaries of the economy itself into the sphere of social relations: sellers and buyers of labor agree on the terms of the “transaction” as equal participants in the social contract. The Western European model of social partnership, especially in its German version, has long gone beyond sectoral tariff agreements.

Two features most clearly characterize the system of social partnership in Germany. Firstly, it is the “principle of complicity”, which provides for the participation of employee representatives in the work of supervisory boards with the right of a decisive vote in the discussion of wages, working conditions and personnel policy. It gives employee representatives a real right to participate in the management of the enterprise and thereby turns them into partners of employers. Workers enjoy a very high degree of social protection, such as protection against dismissal. It is noteworthy that the supervisory boards include representatives of a particular labor collective, and not a trade union. The essence of this rule is to protect supervisory boards from socio-political conflicts, often brought to enterprises by trade unions.

Secondly, it is a significant restriction on the right to strike. According to the law, disputes must normally be referred to a conciliation body consisting of workers’ representatives, employers and an independent chairman.

The tools of german and other Western European economies are far from being limited to the principles and mechanisms described. They form the core of the social market economy model and are of interest from the point of view of the development of reforms in post-socialist countries. Along with this, it should be noted that, for example, German experts themselves are not yet quite sure that the formed economy is a social market economy. Therefore, repeating, copying the economic model is hardly good advice. Another thing is the use of healthy ideas and principles. However, they require special adaptation in different regions and countries.