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Der Open-Access-Publikationsserver der ZBW – Leibniz-Informationszentrum Wirtschaft

The Open Access Publication Server of the ZBW – Leibniz Information Centre for Economics

Siebert, Horst

Working Paper

Principles of the economic system in

the Federal Republic : an economist's

view

Kiel Working Papers, No. 398

Provided in cooperation with:

Institut für Weltwirtschaft (IfW)

Suggested citation: Siebert, Horst (1989) : Principles of the economic system in the Federal Republic : an economist's view, Kiel Working Papers, No. 398, http://hdl.handle.net/10419/518

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zbw Leibniz-Informationszentrum Wirtschaft Leibniz Information Centre for Economics Kieler Arbeitspapiere Kiel Working Papers Kiel Working Paper No. 398 Principles of the Economic System in the Federal Republic An Economist's View by Horst Siebert —- i i t Institut fiir Weltwirtschaft an der Universitat Kiel The Kiel Institute of World Economics ISSN 0342-0787 Kiel Institute of World Economics Dusternbrooker Weg 120 2300 Kiel 1 Federal Republic of Germany Kiel Working Paper No. 398 Principles of the Economic System in the Federal Republic An Economist's View by Horst Siebert October 1989 The author himself, not the Kiel Institute of World Economics, is solely responsible for the contents and distribution of each Kiel Working Paper.

Since the series involves manuscripts in a preliminary form, interested readers are requested to direct criticisms and suggestions directly to the author and to clear any quotations with him.

Principles of the Economic System In the Federal Republic An Economist's View

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Germany's "social market economy" has its roots both in historical experience and in a value orientation centered around the individual. The immediate historical background is to be found in the years of an Orwellian dictatorship repressing individual tastes and individual behavior. Another aspect of the German experience was the interventionism of the state and the central planning mechanism that slowly developed in the late 19th century and became dominant in the war economies and in the thirties. The inflation of 1923, the repressed inflation of 1936-1948, the problem of the alienation of the worker in the 19th century and the endogenous erosion of competition through large firms also formed part of the historical background. The consensus of the founding fathers of the Grundgesetz was a value orientation stressing individual freedom, human dignity and the subsidiarity of societal organization.

Paper prepared for the German-American Conference on "Federal Republic of Germany - 40 Years of the Basic Law. Experience and Prospects". Subsequent publication in preperation. Distributed here with the permission of the Drager Foundation.

I appreciate comments from Klaus-Werner Schatz, Karl-Heinz Paque and Holger Schmieding.

1. The Basic Principles In this paper, we shall not study in detail the concept of the founding fathers of the social market economy (Miiller-Armack 1966, 1978; Ropke 1958, 1963; Giersch 1960; Watrin 1979) and the system introduced in 1948. Instead, we shall mainly look at the social market economy in actual practice ("Verfassungswirklichkeit"); moreover, we are interested in the challenges the future holds.

Individual Liberty

Due to the experience of having been under a dictatorship rule and in accordance with the constitutional history in Europe, the first articles of the Grundgesetz define the rights of the individual. The "dignity of man" (Art. 1 ), "inviolable and inalienable human rights" (Art. 1 ), "the right to the free development of one's personality" (Art. 2 ), "the right freely to express and to publish one's opinion by speech" (Art. 5 ), the "freedom of movement" (Art. 11), the "rights of ownership and inheritance" (Art. 14) and many other provisions show that the corner stone of the Grundgesetz is to respect the decisions of the individual. In terms of economics, the basic presumption of the Grundgesetz is that individual preferences should count, that it is for the individual to decide. One is free to choose what to consume, whether to consume or save, whether to work or enjoy leisure, which job to take, where to live, where to travel, and what to produce for someone else.

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.A system.that is ultimately.geared towards(the preferences of the individual^ must have aninstitutional mechanism by which-the individual can voice his ^preferences. The ^institutional vehicle





•is the market or a set of. markets: the competitive.order. If a market1:: economy•..-:is established by an adequate institutional framework:/ the individual can vote with his purse and with his feet. By giving up income and by spending money on a specific product and not on alternative products-, the individual clearly signals his opportunity costs and his marginal willingness to pay. By choosing one place to live and not another one, he indicates his willingness to pay for a specific location. By deciding how many hours to work or not to work, he indicates his evaluation of work and leisure. When these individual evaluations are summed up by the market, the value of a good from the point of view of the demand side is specified.

Economic decentralization not only refers to revealing the marginal willingness to pay. Markets also allow a decentralized autonomy of decisions on production and investment; they signal the incentives to produce. By expressing opportunity costs, i.e.

the costs of an opportunity foregone, the market economy prevents inefficiency. Firms making a loss have to exit because their opportunity costs are too high: the resources could be used better elsewhere.

Information on economic and technical conditions is not ubiquitous in an economy but is distributed assymmetrically among the subsystems. Decentralization allows the utilization of comparative advantages in the generation and processing of information; it is an incentive to collect and reveal information.,t....:-..

The competitive order not only satisfies the conditions for static efficiency, it,also provides,,for dynamic efficiency. Firms search for new technical knowledge and look for new possibilities for investments. Thus, markets are not only a mechanism to disseminate a given set of information, they are an exploratory device in the sense of Hayek (1968) generating new knowledge.

The competitive order is not explicitly written down in the constitution. It may be questioned whether it is a principle in its own right as stated by Eucken (1952, p. 254) who regards it as the only basic principle, or one may take the view that the competitive order is instrumental in allowing individual liberties. Decentralization allows personal choice and provides options. Thus, decentralization is part of an open society (Popper 1944). Still, other writers may link the competitive order to the overall target of efficiency (the economic principle).

Equity

Besides giving freedom to the individual, the constitution also protects the individual. Thus, no one is allowed to violate the right of others (Art. 2 ) ; property imposes duties (Art. 14); and the Federal Republic is a "social federal state" ("Sozialer Bundesstaat", Art. 20). Equity enters other stipulations in the constitution such as preventing regional disparities in living conditions (Art. 72). De facto, there is a strong material protection of the individual, especially through a net of mandatory social insurance systems including unemployment, disability and old age insurance. The market as an allocation mechanism is corrected in order to attain results which are socially acceptable.

2. The Social Market Economy as an Economic Order

The principles of individual liberty, competitive order and equity do not yet fully specify the economic system of the Federal Republic. The "social market economy" must be understood as an institutional arrangement defining the rules for the decision making of households, firms, and the politicians, including the restraints as well as the incentives.

The Concept of Economic Order Soziale Marktwirtschaft has to be interpreted as a specific form of a "Wirtschaftsordnung". It is an "ensemble", a frame of reference, a self-regulating system with the targets of individual freedom and choice, efficiency through decentralized autonomy in a competitve order and equity.

A "social market economy may be described as a permanent search for an economic and social framework, designed to encourage both an efficient production of the means of material well-being and personal freedom in a socially-balanced order" (Watrin 1979, p. 419).

An important strand has developed in the literature of institutional economics - that of the principal-agent paradigm, where the principal sets rules that influence the behavior of the agent, where the principal cannot fully observe the behavior of the agent, yet where the behavior of the agent determines the result of the activities. In a way, Wirtschaftsordnunq is a super principal-agent contract. The principals are (i) the fathers of the constitution and (ii) the legislature when it has the appropriate majority for constitutional changes and the normal majority for other legislative alterations. To some extent, the judiciary plays the role of the principal when the rules are interpreted anew. The individuals (the households and the firms) are the agents that can behave according to the incentive structure and the institutional framework developed by the principal. The principal wants to reach its maximum in its targets of freedom, efficiency and equity, for instance by maximizing one target subject to restraints from the other targets. In an optimal solution, the principal will devise rules so that the optimality conditions of the agent are satisfied.

The description of the Wirtschaftsordnung as a super principal-agent problem is not yet complete. To some extent, the voter becomes the principal when he is discontent with the institutional conditions prevailing and when he wants a change.

However, in contrast to specific policy areas, the rules of the game require constancy and ought to change only under rare conditions. This is especially true for constitutional change.

"Denken in Ordnungen" "Denken in Ordnungen" - to think in terms of an order was a central demand of the founding fathers of West Germany's social market economy. They were concerned with the question of how a small institutional change affects the overall system after all the households, all the firms and other agents such as the policy makers have reacted. In a cybernetic context, it is the question of how the system changes if the rules are slightly altered. This is analogous to the general equilibrium analysis for an institutional arrangement (see the concept of "market conformity" below). It seems to me that this concept of "Denken in Ordnungen" is not understood by many economists in the United States.

Hutchison (1981, p. 162) may come closest to the concept of Wirtschaftsordnung by distinguishing between a Ricardian and Smithian mode of the competitive market economy (Vanberg 1988, pp. 16 f.). The Ricardian concept stresses

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