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 concept's roots go back to Ludwig Erhard, who served from 1949-1963 as the first Economics Minister of the Federal Republic of Germany. The central idea of the social market economy is to protect the freedom of all market participants on both the supply and demand side, while simultaneously ensuring social equity. Erhard's colleague Alfred 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.

Markets balance supply and demand via the mechanism of prices. When high-demand goods become scarce, their prices rise. This reduces demand while simultaneously opening up profit opportunities for additional suppliers. Suppliers will attempt to keep production costs as low as possible. This process fosters the efficient use of the means of production and lower prices for consumers.

In order for this system to function effectively, it is crucial to guarantee competition within a framework of open markets and to 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. One of the key responsibilities of government is to establish the policy 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.

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. This means providing an effective level of social security for people unable to earn market incomes due to age, disease, or unemployment. However, because the emphasis on social equity should not constrain market freedom, the key task is to strike the proper balance between both principles. Social benefits and government programmes are financed through tax revenues. But taxes are a burden on those people whose incomes generate prosperity. Therefore, the aim is to achieve a solid level of social security while ensuring the highest possible level of prosperity. Ludwig Erhard himself understood: the more successful a country's economic policy is, the less need there is for social assistance.

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.