Social market economy

Since the mid-20th century, Germany's economic policy has been based on the concept of the social market economy (soziale Marktwirtschaft). The central idea of this concept is to maintain the mechanisms of the free market while simultaneously ensuring social equity.

Market mechanisms function by balancing supply and demand. This balance determines market prices. In order for these processes to function effectively, it is important to guarantee competition and prevent the exercise of market power. In this way, market mechanisms expand consumption opportunities, motivate suppliers to make innovations and technological advances, and distribute income and profits in accordance with individual achievement. At the same time, these mechanisms can prevent the excessive accumulation of market power.

It is the responsibility of the state to establish the framework for effective competition. At the same time, the state must foster the willingness and ability of individuals to take personal initiative and to act independently. It must not stifle these essential individual qualities by allocating too much responsibility to state institutions. State action requires taxes, which represent a burden to the economy and society; this burden falls primarily on labour and thereby limits the ability to dispose of income freely.

As a complement to the principle of free markets, the concept of the social market economy includes a second principle: the principle of social equity. To the extent possible, the emphasis on social equity should not constrain market freedom. Nevertheless, it is important to avoid the downsides of free markets, including destructive competition, the excessive concentration of economic power, and socially inequitable impacts of market processes such as unemployment. For this reason, the state pursues social policy measures as a way of actively intervening in market processes. The aim is to achieve the greatest possible degree of social security while ensuring the highest possible level of prosperity.

Ludwig Erhard

The concept of the social market economy was developed by Ludwig Erhard, together with Alfred Müller-Armack. Erhard, who served from 1949-1963 as the first Economics Minister of the Federal Republic of Germany, was a proponent of Ordoliberalism - a school of economic liberalism that also accorded a key role to the state. The fundamental principle of Ordoliberalism is the protection of all market participants on both the supply and demand side. Erhard's colleague Müller-Armack, who headed the Economics Ministry's Directorate-General for fundamental issues of economics policy starting in 1952 and then became State Secretary for European policy in 1958, was the first person to put the term "social market economy" in writing. He described the "social market economy" as a form of market economy that - in contrast to a laissez-faire market economy - is intentionally managed in accordance with social priorities.

Legal basis

The term "social market economy" was never specifically named in Germany's constitution as the country's economic system, because the constitution does not contain a separate section on the economy. Nevertheless, central elements in Germany's legal system - including its basic rights, the freedom of association and contractual freedom, and the freedom to choose a profession and place of employment - lay the foundations for the social market economy and exclude extremes such as a centrally planned economy or an unfettered market economy.

In May 1990, the Treaty establishing a Monetary, Economic and Social Union between the Federal Republic of Germany and the former German Democratic Republic set forth in law that the social market economy constitutes Germany's common economic order.

A solid basis for the long term

A forward-looking economic policy must be grounded in transparent, consistent economic concepts and principles that encompass clear goals and measures. This policy must have the trust and support of both business and society. It must also ensure that economic activities may be planned with certainty, thereby helping to foster individual initiative.

Ludwig Erhard himself understood: the more successful a country's economic policy is, the less need there is for social assistance. Yet our society must assume social responsibility for those who, on their own, are not sufficiently capable of partaking in our society's prosperity. In this way, we can also help to ensure broad-based acceptance of structural changes in the economy.