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Chapter 4 The Social Market Economy (latest revision June 2008)

Market capitalism has been categorized in a variety of ways. In this course, we will use a simple dichotomy: liberal market capitalism and the social market economy. Liberal market capitalism was the version of the market economy described in Chapter 2. This chapter will consider the social market economies. Both the liberal market economy and the social market economy are variations of capitalism. This means that in both systems, most of the capital goods are privately owned. But there are significant differences in the two variations of capitalism. What is called “the social market economy” has also been called “Social Democracy” or “Democratic Socialism”. Although there are differences, we will use these terms interchangeably here. The social market economy is associated mostly with Europe. But it should be noted that not all of the European countries are social market economies. The countries we will consider as social market economies are Germany, Austria, Switzerland, Belgium, the Netherlands, and the Scandinavian countries of Denmark, Sweden, Norway, and Finland. Britain once was a social market economy. But today, Britain is much more like the United States – a liberal market economy. The same can be said for Ireland. France, Italy, and Spain have elements of both types of capitalism. Japan is quite different from either type and will be considered in some detail later in the course.

1. The Basic Philosophy of the Social Market Economy

Let us begin by examining the philosophy of the social market economy. As we will see, people who support this variation of capitalism accept many aspects of the theory of liberal market capitalism that was explained in Chapter 2. But they also accept some aspects of the Marxian view that was described in Chapter 3.

The first aspect to emphasize about the philosophy of the social market economy is that it is democratic. Unlike the Marxian view, supporters of the social market economy do not seek violent revolution. They believe that all social changes should be accomplished peacefully, gradually, and only after they are widely accepted by the people. Supporters of the social market economy usually form political parties and stand for elections. These parties, often named “Social Democratic” or “Labor” Parties, sometimes win the ability to govern and sometimes do not.

Rather than rejecting democratic government, as Marx did, supporters of the social market economy believe that democratic government needs to be extended. For example, they believe that the modern large corporation has important social effects and therefore needs to be brought more under democratic government control. This contrasts with the views of supporters of liberal market capitalism who see the modern corporation as the private property of its owners with the singular task of trying to earn as much profits as it can. (In the United States, this contrast is illustrated by the dispute between some communities and Wal-Mart over attempts by Wal-Mart to open superstores in the community.)

Supporters of the social market economy also often desire to extend democratic government into areas such as work relations and education. They believe that a worker should have the same rights as a citizen does. Just as one is not subject to the arbitrary control of a superior in a political democracy, they believe that one should not be subject to the arbitrary control of an employer while on the job. This contrasts with the view of supporters of liberal market capitalism that the job is the private property of the employer. (For example, I cannot be punished for criticizing the President of the United States in public. But I can be fired for criticizing my employer in public. Is this right?)

The second aspect to emphasize about the philosophy of the social market economy is that it is moralistic. Unlike Marx, the supporters of the social market economy do not reject religion. Indeed, many supporters are religious clergy. Is liberal market capitalism consistent with being a moral person? Many of the supporters of the social market economy believe the answer is “no”. They see a goal of an economic system as being “to eliminate all unnecessary suffering caused by economic or social structures”. They argue that liberal market capitalism often creates such unnecessary suffering. The creation of an adequate “social safety net” is a big part of the social market economy, as we will see later in this chapter.

The third and most important aspect to emphasize about the philosophy of the social market economy is that it is egalitarian. This does not require that everyone have the same income or wealth. But it does require that “no one is so much richer or poorer than another that they cannot mix socially on equal terms”. Supporters of the social market economy realize that some people will earn more than others. This ability to earn more provides incentives to work hard, to improve one’s skills, to develop new products, and so forth. But supporters of the social market economy believe that inequality should be sufficient to provide such incentives, but no greater. Or as a famous Danish bishop put it, each country should be such that “no one has too much and no one has too little.” The supporters of the social market economy have provided several arguments on behalf of equality.

First, it has long been accepted in Economics that as people have more of a product, an additional unit of the product brings less additional satisfaction. So, for example, having a car would bring great satisfaction if one had never had a car before. But how much additional satisfaction could there be to having another car if you already had ten cars? Based on this reasoning, taking income away from very rich people would not cause them great hardship. They already have so many goods and services that the loss would mean little to them. (The manager of a leading hedge fund recently had an income of $3.5 billion in one year. If $500 million were taken away from him in taxes, leaving him with $3 billion, how much would he lose? After one has spent $3 billion in one year, what more is there to buy?) On the other hand, giving income to poor people would bring them great satisfaction. So for example, imagine we took the $500 million and used it to give $50,000 each to 10,000 people whose total income had been under $20,000 per year. How much would these 10,000 people gain? Each would go from being poor to being middle class. For each, their life situation would improve dramatically. The argument here is that the gain to these 10,000 people would be greater than the loss to the hedge fund manager. Society as a whole would be better-off by redistributing income from the very rich to the very poor.

Second, an American philosopher came up with the following argument for equality. He asked you to imagine that you are about to be born. You can create the distribution of income that you wish for the world you are being born into. You can have many rich people and many poor people. You can have everyone equal. You can do as you wish. The only problem is that you do not know where you will be in this distribution. If you have few rich and many poor, you don’t know whether you will be rich or poor. He argues that in this situation, most people would choose the distribution to be relatively equal. This minimizes the worst thing that could happen to you. Since people would choose relative equality if they did not know their own position, that must be the most desirable distribution.

A third argument for equality is that supporters of the social market economy see inequality in income as generating inequality in political power. While everyone has only one vote, those who can provide large campaign donations are more likely to have their favored policies enacted. Democracy does not work well if some people can buy more political influence than other can. Supporters of the social market economy see inequality as fostering divisiveness and breaking down social cohesion. The rich live in gated communities. The poor live in ghettos. There is no sense of community or common purpose between them. This is especially likely to be true if the rich and the poor are of different ethnic backgrounds. And supporters of the social market economy see economic inequality as destroying equality of opportunity. One economist wrote of a crew race that has taken place in London for over 200 years. Each year, the race begins where the race of last year left off. So if one side was ahead by 500 yards at the end of last year’s race, they begin this year’s race 500 yards ahead. Needless to say, if one side had been particularly bad 100 years ago, that side would have no chance in this year’s race. The analogy is that if one side (the rich) is well ahead of the other side (the poor) because of something that happened over 100 years ago (such as slavery), the other side would have little chance of ever catching up. There would be no real equality of opportunity.

A fourth argument for equality is that supporters of the social market economy see market transactions as analogous to voting. Every time you buy something, you are, in essence, “voting” for it to be produced. In the political process, each person has one vote. But in a market, some people have many more votes than others. Obviously, the goods and services they desire are the ones that are produced. So, for example, wood is used to produce yachts for rich people while other people are homeless. Supporters of the social market economy believe there are some goods and services that are just too important to be mere commodities in the market. These would include education, health care, and housing. In their view, these should be available to all.

For all of these reasons, supporters of the social market economy are strong believers in policies that will make people more equal. We will examine some of these policies, especially those that relate to labor markets and those that relate to the “welfare state”, in later parts of this chapter. It should be noted that surveys show that Europeans are more likely to believe that high incomes are due to luck or to one’s social class at birth. Americans are more likely to believe that high incomes are the results of individual effort. The differences in these beliefs are large.

Supporters of the social market economy strongly criticize liberal market capitalism. Some of these criticisms have been noted earlier. For example, they criticize the liberal market capitalist economy for generating large inequalities in the distributions of income and of wealth and in the distribution of power between corporations and workers. But they also provide other criticisms that are similar to the Marxian criticisms of capitalism. They believe that liberal market capitalist countries are subject to too many periodic recessions with all the difficulties that unemployment brings. They believe that major parts of the liberal market capitalist economy are subject to monopoly. And they believe that having all countries become liberal market capitalist economies would increase the disparities between the rich countries and the poor countries of the world.

But supporters of the social market economy also strongly criticize communism, as it was practiced in Eastern Europe and China. They criticize communism for being non-democratic and not legitimate (that is, communism was not accepted by a majority of the people). They criticize communism for its restriction of personal freedom and for its lack of concern with basic liberties and human rights. They see communism as an alienating and dehumanizing economic system that has simply replaced one ruling class with another ruling class. Communism, as it was practiced, with be discussed in detail in later parts of this course.

Supporters of the social market economy used to call themselves a Middle Way or a Third Way --- a view of an economic system that is between liberal market capitalism and communism. As we examine the workings of the social market economies, we will see that over the past twenty years, they have shifted more in the direction of the liberal market capitalist economies. But they are still different. It is that difference that we will be studying here. There are three important aspects that differentiate social market economies from liberal market capitalist economies. Before we discuss these three, we will briefly discuss two other aspects that once were major differences: social ownership and economic planning. These are not significant any more in social market economies. Then, we will turn to the main differences that still exist. First, social market economies have much more tightly organized business communities. Second, social market economies have strong labor unions, institutionalized collective bargaining, and strong employment protection. Third, social market economies have large-scale government provision of social welfare.

2. Social Ownership

One institution that distinguished the social market economies after World War II was social ownership or nationalization. Unlike the situation we will discuss in the Soviet Union, nationalization was to be done only for certain companies, not for all companies. And also unlike the situation in the Soviet Union, nationalization was to be done with compensation to the former owners. The companies that were chosen for nationalization varied among the countries. But generally, they fell into the following categories. First, supporters of the social market economy believed that certain industries are prone to monopoly. Called “natural monopolies”, these are industries in which the amount of capital goods needed to produce is very large. Therefore, only large companies can afford the capital goods. Once the capital goods are in place, the additional cost of producing more is very low. (To produce more, the company just gets more use of the capital goods it already has.). In this situation, the industry will evolve to where there is one company (or perhaps just a few companies). With little competition, the companies in these industries could exploit the consumers. Industries in which the companies were nationalized for this reason include electricity, natural gas, railroads, and the post office. In Britain and France, the government also owned some of the automobile companies as well as shipbuilding companies, some steel companies, and the aerospace companies. (In the United States, electricity and natural gas are allowed to be produced privately but are regulated by government agencies.) Second, in some countries, companies were nationalized to remove what were seen as excessive private economic power. The main example of this was the nationalization of banks in some countries. Third, companies that were in industries seen to have great national importance but in which the companies could not make satisfactory profits were often nationalized. An example was the television networks, such as BBC. Fourth, some companies were nationalized because the government wanted to force them to pursue what were seen as important social purposes. So in all European countries, payment for health services has been nationalized. National Health in Britain will be described below. And finally, in some countries (especially Britain), companies were nationalized when the government believed that it could reorganize them so as to improve economic performance. Examples include the airline companies (British Airways, the Irish airline Aer Lingus, and the German airline Lufthansa were government owned for many years), the coal mines, and the steel companies.