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«Is it more liberal or just newly organized? Systemic consequences of the German social system reforms Sebastian PŁÓCIENNIK University of Wroclaw, ...»

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ISSN paper version 1642-2597

ISSN electronic version 2081-8319

Economic and Environmental Studies

Vol. 10, No. 4 (16/2010),433-446,Dec. 2010

Is it more liberal or just newly organized?

Systemic consequences of the German social

system reforms


University of Wroclaw, Poland

Abstract: A decade ago Germany started reforms of its economic system, in particular of the famous social market

economy. There are still controversies on how to understand the changes and what has been their institutional impact. Has Germany really converted to a more liberal, market oriented system? Or have the reforms contributed to an incremental change, which essentially preserved traditional features while marginally adjusting institutions to new challenges? This article proposes a framework which could be useful in searching qualitative answers to these questions, referring to relations between institutions and varieties of capitalism. This makes it possible to put the

reforms of the unemployment, old-age and health care insurance into the broader context of other changing domains:

financial system, labor market and skills formation. It is concluded that Germany has neither held on to its traditional institutional features nor switched radically to market solutions. It has rather developed clever hybrid institutional solutions which help to react to endogenous pressures, like aging of the society, and to exploit advantages of financial globalization.

Keywords: Economic system, institutions, Germany, social policy, institutional change

1. Introduction In the wake of economic turmoil of the recent years complexity has become a buzzword obviously without any positive overtones. Politicians use it as an explanation for failed reforms or an excuse for avoiding any (Mayntz, 2006) and economists blame it for erroneous forecasting.

What is actually “complexity”? John Casti points out its four “fingerprints.” It is, firstly, instability: complex systems tend to have many possible modes of behavior and even a marginal Correspondence Address: Sebastian Płóciennik, University of Wroclaw, Faculty of Social Sciences, ul. Koszarowa 3, 51-149 Wroclaw, Poland. E-mail: sebastian.plociennik@uni.wroc.pl.

© 2010 Opole University Sebastian PŁÓCIENNIK change in the environment can cause a modification. It is also irreducibility, which means, that a complex system is a united whole which cannot be studied by breaking it into components.

The third trait is adaptability. It comes from presence of intelligent agents who are able to search for different ways to approach one problem. Such systems are also emergent, in other words, able to develop a surprising, new behavior (Casti, 1986: 160-161; Allen, 1998: 4-8; Casti, 2001;

Beinhocker, 2007: 124).

How to deal with complexity if we want to analyze economic systems? How to describe their changes? An attempt to look for an answer needs three basic assumptions. The first one concerns the ways in which actors make decisions under uncertainty and risk. They use analogy, benchmarking, instinct, etc. The most important means of making complex reality simpler are, however, “established and embedded social rules,” i.e., institutions (Hodgson, 2006: 18).

The second assumption is that institutions are interrelated. According to Deeg (2007: 613) they can be complementary, cohesive, compatible and clustered. Complementarity occurs when efficiency of an institution is higher because another institution exists (Hall and Gingerich, 2004;

Boyer, 2005). This type of relation can have a supplementing or synergetic character. The first case describes a functional relation, which follows from nature or technology (e.g., institutions regulating oil delivery and oil transport or stock issue and supervision over investors). Synergetic relation is more sophisticated. It concerns institutions which structure behavior in different domains of economic activity, but they support similar approach, e.g., the expectation that goals can be achieved in a short term perspective. Such a relation is advantageous for strategic action – a very important way to reduce costs of complexity, because it allows following the same scheme in different situations. Other relations are less sophisticated. Cohesion means that institutions share the same fundament of values, ideology or culture, which does not necessarily increase their effectiveness. In case of compatibility institutions can coexists without significant conflicts.

The third assumption says that some institutions are more important for efficiency of economic systems than others and so are the relations between them. This is why when considering different varieties of capitalism focus is on firms and institutions which shape capital markets, labor markets and skills formation. We can call them “first order domains” because they concern the most fundamental resources. There are also second order domains, such as the welfare regime, organization of companies‟ interests and macroeconomic politics. They describe how actors produce other important goods, like stability and legitimization.



Institutions and relations between them are decisive for the competitiveness of an economy. Arrangements, which encourage firms to short term behavior, support radical innovations. Others, rewarding more stable and long term oriented action contribute to incremental innovations. Both strategies shape what Hall and Soskice call comparative institutional advantage (ICA). It is also the bedrock for characterizing economic systems (Hall and Soskice, 2001: 23-26). Liberal market economies (LME) are assumed to be the “flexible” ones, coordinated market economies (CME) – long term oriented. However, between these two poles there is a wide field of multiply equilibriums with mixed systems (Busch, 2006: 19) These three assumptions offer a useful framework to analyze qualitatively both the state of economic systems and its evolution. It makes it possible to localize reforms in specific domains and then analyze the impact on institutions of other domains. In this article, it will be tried to apply this approach to the case of Germany and its welfare state reforms.

2. Germany as a CME

The German economy has been classified usually as a typical CME. It has developed specific institutional arrangements commonly named the “social market economy” or the “Rhine capitalism” (Albert, 1993; Abelshauser, 2004). How to describe its most distinct features? Let‟s start with the capital domain. In the traditional, post-war German system capital was provided by banks. Stock markets did not play a significant role. Corporate governance matched into the scheme by granting investors direct influence on the firm‟s management, mainly via seats in supervisory boards. This solution supported long term relations between banks and firms and contributed to relatively easy access to “patient” capital (Luetz, 2006: 26-28).

The second domain, labor, was ruled to a large extent by highly structured and routinized negotiations between trade unions and employers organizations on the level of industrial branches. In addition to that workers had important co-determination rights in decision making in firms (Mitbestimmung) and the state guaranteed legal protection against dismissal. In general, the labor relations can be described as long term oriented with wage structure flatter than in LMEs.

This solution is connected with the way in which German firms got access to skills. The regulated wage setting and long term orientation of employment discouraged poaching on the


branch level and hampered flexibility of labor. This made in-house skills formation an attractive option for firms, because the threat to lose investments in training seemed to be low.

As a consequence, Germany has a very original and effective two-pillar system, in which pupils study simultaneously in schools and in firms.

All the institutions can be characterized as complementary. Thanks to them Germany developed a very efficient profile of “qualified mass production.” Its firms got successful in top quality industrial products developed in long term processes, which usually occupied profitable niches and rather avoided competing in scale and costs. The country became exporter in branches

like cars, machines, electro-technic devices and chemical products (Hall and Soskice, 2001:


This arrangement was backed by second rank domains, from which the social insurance played probably the most important role. Its goal is to provide actors with alternative income in case of job loss or inability to work due to old-age, disease, etc. In this way not only skills of workers are assumed to be protected, but also the level of consumption in the economy is stabilized and legitimization of the entire capitalist system supported. As a consequence it was easier and less costly for firms to adjust to changes in the market via wage reduction or dismissals.

Stemming from the Bismarckian industrialism and local self-government traditions (Pilz, 2004: 21-47) the social system became an ideological and political fundament of the new Federal Republic of Germany after the second world. There are three dominating branches of social insurance: unemployment, old-age and health care. How did they match into the traditional “Rhine capitalism”? To answer the question we need to look into two areas: financing and spending.

All branches in the pre-reform version of the social insurance were mainly financed from contributions of both employees and employers. This solution had a direct impact on the price of labor. It was claimed, particularly by companies, that costs of contributions discourage them to create new jobs. However, the shared responsibility of employers and employees reflected

the same functional logic which reinforced collective bargaining and a broader systemic feature:

smoothing labor conflicts and supporting cooperation in adjustment processes. All insurance branches were organized as pay-as-you-go modes, thus their relations with the capital domain were actually neutral. High level of contributions was not neutral for skills formation. By making



net income lower it diminished incentives for individual investment in education. This explains actually why the state and companies are so active in this field.

Another side of the system – benefits and services provided by the social insurances – had

strong impact on the labor domain and skills formation. In general the message was clear:

workers can feel secured against social risks thus they do not need to search solutions in strikes against employers. Obviously, this functional relation had a specific “Rhine” shape. Firstly, generous social insurance was connected with full time, dismissal-protected labor contracts. This should encourage actors to look for this type of employment, thus increase labor supply and make alternative costs of free time and untypical employment higher. A side effect was, however, that long-term, high and unconditioned benefits made working in general less attractive. Secondly, the level of benefits paid to entitled persons in the unemployment insurance and pension insurance was contingent to the level of his/her previous wage. This made investment in new skills more attractive as they led to higher wages and higher benefits. The same function had affordability of the benefits, which encouraged workers to investment in rare and risky specialization. Even if they lose jobs, long term benefits (including health care) grants enough time to retrain. The unemployment insurance guaranteed up to two years contains support from, firstly, the unemployment benefit and thereafter from the unemployment aid. A similar logic can be found in the pension system which expanded via early retirement programs – in particular in the 1980s.

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