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«Abstract The quest for an appropriate development and transition strategy in less developed countries (LDCs) and post-socialist countries (PSCs) has ...»

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Joachim Ahrens

Transition towards a Social

Market Economy? Limits and

Opportunities

Diskurs 2008 – 5

Joachim Ahrens

Transition towards a Social Market Economy?

Limits and Opportunities

Abstract

The quest for an appropriate development and transition strategy in less developed

countries (LDCs) and post-socialist countries (PSCs) has been studied for a long

time, and it has been subject to numerous controversies among academics and

development practitioners alike. Disputes have existed with respect to sequencing, timing, and pacing reforms, regarding the components of stabilization-cumadjustment programs, and also relating to the question which actors can become effective drivers of transition and development. Today, a widespread consensus exists that institutions and governance matter for making market-oriented policy reform succeed and that governments, despite the general need for less state interventionism, remain central actors for institution building and rule enforcement.

The following considerations focus on the question whether or not the concept of the Social Market Economy, as it was originally developed and designed by German academics and policymakers more than fifty years ago, will be appropriate to guide policy and institutional reform in LDCs and PSCs and to make market-oriented reforms a viable policy choice in such countries regardless of their political regime.

Keywords:

Less developed countries, post-socialist countries, transition, social market economy Joachim Ahrens Private Fachhochschule Göttingen Private University of Applied Sciences Goettingen Weender Strasse 3-7 37073 Goettingen Germany E-mail: ahrens@pfh-goettingen.de Phone: +49 551 547 00116 Joachim Ahrens Transition towards a Social Market Economy? Limits and Opportunities

1. Introduction The quest for an appropriate development and transition strategy in less developed countries (LDCs) and post-socialist countries (PSCs) has been studied for a long time, and it has been subject to numerous controversies among academics and development practitioners alike. Disputes have existed with respect to sequencing, timing, and pacing reforms, regarding the components of stabilization-cumadjustment programs, and also relating to the question which actors can become effective drivers of transition and development. Today, a widespread consensus exists that institutions and governance matter for making market-oriented policy reform succeed and that governments, despite the general need for less state interventionism, remain central actors for institution building and rule enforcement.

The search for a suitable strategy has been aggravated because a general theory of development and transition does not exist. Several historical role models, however, can be identified which may provide general guidance for policymakers.

Besides the model of a liberal market economy, as it has been applied, e.g., in the United States, other market-based models can be identified such as the Scandinavian model of the welfare state or the German model of a Social Market Economy. The latter could be of particular relevance for LDCs and PSCs because it appears to combine the advantages of a liberal market economy in terms of economic efficiency with the advantages of a welfare state in terms of social justice.

The following considerations focus on the question whether or not the concept of the Social Market Economy, as it was originally developed and designed by German academics and policymakers more than fifty years ago, will be appropriate to guide policy and institutional reform in LDCs and PSCs and to make market-oriented reforms a viable policy choice in such countries regardless of their political regime.

It will be argued that whether or not the transition towards a market economy is successful, i.e. whether it leads to large-scale efficiency gains and sustained economic growth-cum-change, ultimately depends on the implementation of the new rules of the game and their impartial, transparent, and predictable enforcement and, related to that, the societal acceptability and hence political feasibility of the envisaged economic reform and transformation steps. This implies that the concept of a Social Market Economy can be applied in diverse environments, but that the institutional characteristics of the Social Market Economy will be contingent on the stage of socio-economic development, existing political constraints as well as the historical development trajectory of the respective country.

The paper is organized as follows: The next chapter introduces the original ideas and characteristics of the Social Market Economy as it had been conceived by its founding fathers. Chapter 3 discusses the applicability of the concept to LDCs and PSCs. It is argued that a gradual and non-orthodox implementation strategy will be superior to a big-bang approach and that governments need to assume new responsibilities, and therefore must develop novel capabilities and stronger capacities. Furthermore, the notion of best-practice institutions is being rejected.

Instead, it is argued that economic governance is a dynamic process during which transitional institutions may prove to be economically efficient and politically feasible in certain periods of time. In the course of socio-economic development, these institutions may become inappropriate due to changing political, economic, social, and international constraints, and hence they will be replaced by other transitional institutions. This suggests that pragmatic flexibility and policy adaptability are key characteristics of successful policymaking. Institutional frameworks which allow for these characteristics will be best suited to foster economic development. Chapter 4 concludes.





2. The idea of the Social Market Economy

By its founding fathers, the Social Market Economy was conceived as a liberal market economy, based on ordoliberal reasoning, which was social by itself. The original conception of the Social Market Economy was developed in Germany before and during World War II as a potential post-war economic order. After the war, it was politically and visibly represented by Ludwig Erhard, among others. The concept did not allow for the substitution or elimination of market processes through state interventions or the active correction of market outcomes. The idea implied the realization of a market order based on individual self-responsibility with no or only very limited government redistribution. An indicator of the success of the Social Market Economy was said to be the fact that public social transfer payments became redundant due to continuously improving economic performance and all economic actors’ participation therein (Wünsche 1994: 36). Thus, the original Social Market Economy does not develop its social characteristics through artificially imposing apparently social elements (favoring particular groups in society) onto an otherwise free market system. Rather, the attribute social is to be justified through the functions of economic competition and technological progress leading to economic growth processes, which allow a socially just distribution of income increases.

This is what Müller-Armack (1956: 390), who coined the term Social Market Economy, may have had in mind. He defined the concept as “an idea of order policy (..) pursuing the objective, on the basis of a competitive market economy, to link free initiative with social progress which is being assured exactly through market economic performance”1 According to Ludwig Erhard, this, in fact, was supposed to be the driving force to unfold and ensure individual freedom. However, the basic principles underlying the concept of the Social Market Economy do not only include individual freedom and functioning competition. Subsidiarity, solidarity, and responsibility complete the set of basic principles. In order to ensure an efficient functioning of the economic order, to maintain social peace, and to enhance the societal acceptance of this particular capitalist system, solidarity mechanisms need to be in place which support the disadvantaged who cannot sufficiently participate in market processes and earn a living or who are handicapped in another way.

Basically, citizens are supposed to be self-responsible. Hence, in order to make incentives compatible, any public support should be organized in a subsidiary way (Schlecht 2001).

Körner (2007: 19) argues, that, besides the principle of individual freedom, the commandment of social justice equally serves as a foundation of the economic and societal order. This would, however, not allow a onesided interpretation favoring either radical market liberalism or an encompassing, egalitarian social-policy approach. Both principles together constitute a framework for developing and securing a humane economic and social order. Eventually, this concept may help to Author’s translation; the original reads “eine ordnungstheoretische Idee (..), deren Ziel es ist, auf der Basis der Wettbewerbswirtschaft die freie Initiative mit einem gerade durch die marktwirtschaftliche Leistung gesicherten sozialen Fortschritt zu verbinden.“ bundle vested interests, to amalgamate diverse ideologies, and to harmonize different moral concepts.

In order to protect the Social Market Economy, a concentration of economic power has to be avoided. Neither the economic order nor economic policies should be subject to the influence of powerful interest groups or business cartels. Therefore, Eucken (1990/1952) postulated that politics and public policies ought to dissolve powerful economic groups or, at least, limit their functions. Moreover, public policymaking should focus on crafting and impartially enforcing the economic order and should not seek to steer economic processes.

Time and again, the attribute social has been the cause for conflicting political disputes. On the one hand, this attribute helped to gain societal acceptance for implementing the new economic order. On the other hand, the meaning of social remained unclear or was subject to opportunistic (political) interpretations. In the course of post World War II German economic history, the Social Market Economy has undergone a remarkable evolution with substantial reforms, additions, and modifications. These include, e.g., the introduction of a pay-as-you-go pension system, comprehensive worker co-determination rights, substantial social protection, and a generous social transfer system. As a consequence, an affluent welfare state has emerged the financing of which is getting ever more difficult, the incentives of which counteract market principles, and the survival of which is being challenged by globalization forces, demographic trends, and politically opportunistic behavior. The remainder of this paper does not explicitly focus on the actual design and evolution of the Social Market Economy in contemporary Germany.2 Instead, Müller-Armack’s definition serves as a point of departure and reference for addressing the question whether or not the concept of the Social Market Economy can be usefully applied to transition countries.

With respect to this aspect and regarding the need for Germany to re-model its approach to a Social Market Economy in order to address the challenges from globalization and European integration, see, e.g., Vanberg (2007), Streit (2005), and Hass (2007).

Figure 1: Principles of the Market-Economic Order

–  –  –

A market economy is an order which ensures the autonomy of economic actors and coordinates − through the system of flexible relative prices − economic activities which take place within a given market-oriented institutional framework.3 The basic understanding underlying the concept of the Social Market Economy is that a society consists of different orders, the political, economic, and social orders, and that each of these consists of various sub-orders, e.g., the monetary order and the legal order.

Each order is made up of institutions, conceived as formal and informal rules of the game including their enforcement characteristics. These economic, political, and social institutions provide the incentive structure within a society and determine the behavior and actions of individuals. The main task of the government is to establish and enforce this order whithout intervening into economic processes. Thus institution building, or more generally order policy, is the key to bring about a functioning, efficient, and politically feasible market system. Order policy concerns the entirety of rules, which are relevant for the organizational structure of an economy and for economic processes as well as the entirety of mechanisms which are responsible for administering and steering the economy.

Today, it is widely recognized that macroeconomic stabilization, privatization, and price liberalization, though necessary components of economic transition and policy A large part of the following considerations heavily draw from Ahrens (2002a).

reform, are insufficient and that adequate economic rules and regulations must be in place to make incentives work and markets perform well, to reduce transaction uncertainties between private actors, and hence to support private sector development and coordination. In the 1990s, three disparate developments helped reinforce the efforts to put institutions on the reform agenda of policymakers. The first one was the failure of price liberalization and privatization in the Russian Federation and other successor states of the USSR due to a lack of a market-oriented regulatory, legal, and political framework. Another one was the dissatisfaction with economic reforms in Latin American countries and the insight that these policy reforms neglected the importance of safety nets and social insurance. The third one was the Asian crisis in 1997/98 which revealed that financial liberalization without prudent regulation can have disastrous consequences (Rodrik 1999).

The constituent principles of a Social Market Economy elaborated by the German ordo liberal school and, in particular, by Walter Eucken (1990/1952) serve as a useful starting point for identifying key economic institutions which matter for market performance and the evolution of a private sector. Ordo liberals derive their prescriptions for public policymaking from the notion of order which is a fundamental precondition to make governance structures effective.



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