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Press Release from 2019-08-20 / Group, KfW Research

70 years of social market economy: a cause for celebration, several occasions for reform

  • Prosperity has grown sixfold in Germany since 1950 with the social market economy
  • Outstanding combination of economic strength and social balance
  • Need for maintaining labour force potential
  • Urgent need for strengthening investment, innovation and expanding digitalisation
The social market economy has turned seventy. This is cause for celebration, as it brought along the highest levels of prosperity and life satisfaction for Germany and other industrialised countries. A recent study by KfW Research analyses the achievements and shows where there is urgent need for reform.

Only few countries in the world have achieved higher levels of prosperity. In Germany, the population is very satisfied with their living conditions, and in 2017 its per-capita GDP ranked 18th of nearly 200 states.

But there also is significant criticism of the economic system in Germany, fearing that growth is endangered by a too high fiscal burden. There also is a discussion on increased income disparities, and there are demands for greater redistribution. In addition, reforms are required in order to secure the sustainability of Germany’s economy.

"Criticism is justified where there is urgent need for reform. We have to do more to foster growth in an environmentally sustainable manner, and we have to act against increasing income disparities by promoting equal opportunities in the education system and strengthening structurally weak regions. However, it has to be noted that the level of prosperity in Germany has grown sixfold since 1950 due to the social market economy," says Martin Müller, author of the study and Germany expert at KfW Research.

Key results of the study

  • Entrepreneurial initiative not hampered solely because of high taxes and social security contributions

There is no evidence that a high contribution ratio alone does hamper entrepreneurial initiative and economic growth. In 2018 the tax and social contribution ratio was 40.5% of gross domestic product, the highest since the year 2000. However, Germany thus remains in the middle bracket of industrialised countries. Both industrialised countries with low contribution ratios as well as such with relatively high ratios are very successful.

  • Social balance plays an important role in Germany

Due to its consequent labour market reforms, Germany has the second-lowest unemployment rate in the EU. Even if market incomes have become less equal, redistribution in Germany reduces inequality by nearly half. There are few industrial states in which incomes are more equal than in Germany.

Social security expenditure in Germany rose to a record high since 1991. Only two EU countries award higher social benefits per capita of the population.

There are high wealth disparities in Germany. But anyone who carries out well-paid work can move up to the most wealthy 10% of the population when leading a sufficiently frugal lifestyle and investing savings wisely. This is shown by the study, referring to analyses of Deutsche Bundesbank and the German Institute for Labour Market and Vocational Research (IAB). In addition, disparities are much lower when taking into account pension entitlements and differentiating according to age.

"However, there is need for social policy action. Further efforts are needed to reach full employment, and housing must be maintained affordable for low- and medium-income households in conurbations," says Martin Müller.

Calls for far-reaching reforms in Germany are justified

Currently, the need for reform arises less from the level of contributions or the social situation. There are, instead, four pressing challenges:

1) Maintaining the labour force potential despite the demographic trend

According to estimates, the labour force potential will shrink by up to 4.6 million persons of working age by 2040 unless countermeasures are adopted. The undesired consequences would be a loss of competitiveness, widening gaps in the supply of goods and services and growing distribution conflicts.

2) Strengthening unity within the EU and working towards cooperation in global trade

The EU urgently has to strengthen investment and innovation, as well as to consolidate public finances and the banking sector. What is also necessary is an effort to agree on rules for free global trade with the involvement of the USA and China. However, Germany and the EU must protect their legitimate interests in conflicts.

3) Advancing digitalisation successfully

Germany must secure its competitiveness in the digital transformation because it pervades all areas of the economy. Furthermore, digitalisation could help to manage the shortage of skilled labour through technological progress. Rural regions also need to be equipped with a competitive digital infrastructure to keep them from falling behind.

4) Energy transition and ecologically sustainable growth

After noteworthy achievements in the beginning, the greenhouse gas reduction rate in Germany has stalled since 2009. More impetus is therefore urgently needed in this area. However, the turnaround must be global for climate action to be effective. That requires competitive CO2 prevention technologies to crowd out greenhouse gas-intensive technologies on a global scale. Germany and other countries of the climate alliance can advance these technologies. Striving to meet global demand creates great economic opportunities also for Germany. An effective pricing of carbon emissions can contribute to this goal in an economically cost-efficient manner.

The full study is available at: https://www.kfw.de/PDF/Download-Center/Konzernthemen/Research/PDF-Dokumente-Fokus-Volkswirtschaft/Fokus-englische-Dateien/Fokus-2019-EN/Focus-No.-262-August-2019-Social-market-economy.pdf