The process of German economic, monetary, and social union (GEMSU) raises many questions about the role for economic policy, both in influencing the overall degree of resource use in the economy and in pursuing an efficient allocation of resources. This chapter analyzes these questions against the background of past experience with economic policy in the Federal Republic of Germany (FRG). Three major periods of economic policymaking can be distinguished in the FRG: from 1948 until about the mid-1960s, a period of strongly market-oriented policies associated with Ludwig Erhard; from the mid- 1960s to perhaps the early 1980s, a period of Keynesian policies associated with Karl Schiller; and, since the early 1980s, a revival of Erhardian ideas.1

Thomas Mayer

The process of German economic, monetary, and social union (GEMSU) raises many questions about the role for economic policy, both in influencing the overall degree of resource use in the economy and in pursuing an efficient allocation of resources. This chapter analyzes these questions against the background of past experience with economic policy in the Federal Republic of Germany (FRG). Three major periods of economic policymaking can be distinguished in the FRG: from 1948 until about the mid-1960s, a period of strongly market-oriented policies associated with Ludwig Erhard; from the mid- 1960s to perhaps the early 1980s, a period of Keynesian policies associated with Karl Schiller; and, since the early 1980s, a revival of Erhardian ideas.1

The Period of Liberalism: Financing the Essential Government Tasks

Economic policy in the FRG formally began in 1948 with the merger of the U.S., British, and French occupation zones into one united economic area and the currency reform.2 The conceptual framework that governed economic policy, however, was developed much earlier, in the writings of Ludwig Erhard and others, before and during World War II. The writings of these economists reflected a reverence for market forces as the best guide to economic decision making.3 The main task of economic policy was, therefore, to provide a secure and unobtrusive legal and financial framework within which markets could operate efficiently.

Ordnungspolitik, as this policy has been called, allocated clearly defined tasks to each aspect of economic policy, that is, monetary, fiscal, and structural policy. The main task of monetary policy was to ensure stability of prices and the currency. This required the establishment of a strong and independent central bank that was legally bound to pursue these objectives. Thus, the central bank’s commitment to these objectives could not be overruled by the government. Fiscal policy was charged with the role of providing a tax system that generated enough revenue (with as little distortion of market signals as possible) to finance expenditures for the classical tasks of government. There was no room in this concept for fiscal demand management policies and, in fact, the general government accounts were in surplus during the 1950s and the first half of the 1960s (see Chart 11 in Chapter II). Structural policies were seen as passive rather than active: the objective was to provide an economic structure that rewarded competitiveness and facilitated structural adjustment in response to market forces. Strong antitrust laws and laws that ensured fair competition were essential to this objective.4

This description of economic policy should not be taken to suggest that the system was one of virtually unbridled market forces. Indeed, economic policy was constrained by social policy that ensured consensus between the so-called social partners, organized labor and capital. In this sense, there was government intervention to influence market forces. But the intervention was not ad hoc or unpredictable; social policy consisted of a set of rules—similar to the rest of the institutional and legal framework of the economic system—that set the bounds within which market forces could operate. In the thinking of the postwar German “Ordo-liberal” economists, the role of social policy was important, if not vital, to the success of economic policy. This view had historical roots. In postwar Germany, the memory of the close cooperation of big industry with the Nazi regime was still vivid. It was believed that the involvement of labor in industrial management, through workers’ councils and economically strong trade unions, was essential to the well-being of the young democracy and for economic prosperity. On economic grounds, social policy was seen as helping to overcome the traditional antagonism between capital and labor so as to foster a social environment conducive to a smoothly functioning economy.5 The main instruments of social policy were the establishment of comprehensive unemployment, health, and pension systems, as well as institutional regulations that allowed for the representation of labor in the main areas of industry.

The combination of a market-oriented economic policy with an active social policy came to be known as Soziale Marktwirtschaft (social market economy).6 The execution of this policy was fairly straightforward. Once the economic framework was in place, the Ministry of Economics, headed by Erhard, took over the role of the guardian of its principles. Day-to-day management was not required, and the Ministry concentrated on basic policy issues and occasional modifications of the policy framework when these were needed because of economic developments. The other economic policy institutions, the Ministry of Finance and the Deutsche Bundesbank, had an essentially supportive role. To play this role was, however, not always easy. Monetary policy, for example, was often caught between domestic considerations and the external constraints imposed by the Bretton Woods system of fixed exchange rates, as the German target for inflation often differed from those of trading partner countries. In most cases, the record suggests that external constraints prevailed over domestic objectives.7

The rejection of the notion that economic policy should try to steer economic developments was reflected in the relatively small size of government during the 1950s and early 1960s. In 1955, the share of government revenue in GNP was 35 percent (more than 10 percentage points below the share in the mid-1980s, see Table A15 in Chapter II). The share of government expenditures in GNP was only 30 percent (almost 20 percentage points below that reached 30 years later), and the government accounts registered a considerable surplus.

The noninterventionist paradigm of the 1950s and early 1960s, supported by a favorable economic environment, was associated with a buoyant economy: real per capita GNP growth averaged close to 7 percent through the 1950s; unemployment declined from almost 2 million in 1950 to 300,000 in 1960; inflation was below 2 percent on average during 1950–60; share prices rose manyfold in the 1950s; and real interest rates on government bonds averaged about 4½ percent during 1955–60.

The Period of Keynesianism: Restoring Internal Equilibrium

In the early 1960s, the Social Democratic Party (SPD) moved from the left toward the political center. In the area of economic policy, the old, more socialist philosophy was replaced by a moderate Keynesianism. When the SPD formed a government with the Christian Democrats (CDU) in 1966, the ground was laid for the application of these ideas. At the same time, there was also something of an international consensus on Keynesian policies.

The main proponent of Keynesian policies in Germany at this time was Karl Schiller. In contrast to the “Ordoliberal” school, he argued for active demand management policies by the Government with a view to maintaining full employment in the economy. Given the limited scope for independent monetary action in the fixed exchange rate system of the time, the obvious instrument was fiscal policy. The “mini-recession” of 1967 provided the first test case for the application of these policies. After strong growth in 1964–65, the economy had weakened in the course of 1966 and had fallen into mild recession in 1967. Schiller interpreted this development in the following way: “The absence of…a coordination between fiscal and monetary policy as well as between actions of the government bodies on the one hand and the autonomous social forces on the other hand was responsible … for the deepest recession in the Federal Republic in the post war period in 1966–67.”8 The Government reacted with deficit spending and so contributed to a strong economic rebound in the following year. At the same time, a law was enacted that was intended to provide a framework for the regular application of demand management policies (Gesetz zur Förderung der Stabilität und des Wachstums der Wirtschaft or “stability law”.)9

The law stated that fiscal policy at all levels of government (federal, state, and municipal) should be directed at maintaining price stability, a high level of employment, external balance, and appropriate economic growth. These four objectives were to be taken into account when budgets were drafted. But the law also provided instruments—such as expenditure freezes, public borrowing ceilings, and additional government expenditures—to adjust fiscal policy between budgets. Private investment could be stimulated through investment premiums, or it could be dampened through limitations on depreciation allowances. A particularly powerful instrument under the stability law was the so-called tax regulator. Under this provision, prepayments of income taxes could be changed and, if necessary, income and corporation taxes could be raised or reduced by up to 10 percent. All of these instruments could be implemented fairly quickly by the Federal Government provided both houses of parliament agreed.

Although the tax regulator under the stability law has been rarely used since its introduction,10 the spirit of the law influenced fiscal policy during most of the 1970s. Prime examples of Keynesian policies were the Government’s reactions to the first oil price shock in 1974 and the program that it undertook at the time of the May 1978 Bonn economic summit. At this summit meeting of the heads of state or government of the Group of Five countries, Germany and Japan committed themselves to more expansionary fiscal policies, while the United States promised greater fiscal restraint; the objective was for policies in Germany and Japan to support economic growth and, combined with those in the United States, to redress the trade imbalances that had emerged among the major industrial countries. A stimulatory fiscal package, based chiefly on public construction, was introduced with the budget for 1979. However, this investment program, though countercyclical in intention, was not so in effect. Indeed, the increase in public construction in 1979–80 reinforced a boom in private construction and the subsequent drop in public construction coincided with a fall in private construction activity.

The 1967 “mini-recession” had been handled in a textbook manner,11 but subsequent episodes of fine tuning showed up a basic flaw postrecession efforts at demand management proved incapable of reining back fiscal deficits.12 Thus, fiscal deficits and public debt rose during the 1970s and early 1980s to levels unprecedented in postwar Germany as policymakers struggled to deal with an unfavorable external environment (see Chart 11 in Chapter II). In this process, the structure of revenues and expenditures changed substantially (see below). Moreover, as a result of the increase in the share of expenditure on entitlements and debt service, the room for discretionary spending diminished sharply. In the event, these developments contributed to the fall of the SPD/FDP government.

The Revival of Erhardian Ideas

Attempts at “Consolidation”

The second oil price shock in 1979 coincided with the stimulatory effects of the internationally coordinated economic action of 1978 and led to a sharp worldwide increase in inflation. In the FRG, higher oil prices together with the rapid, policy-induced, growth of domestic demand produced, in 1980, the largest external current account deficit in postwar history. At the same time, an international consensus began to emerge that forces had to be concentrated on fighting inflation and that the old recipes of demand management would not help put the world economy back on its feet. In a major change of fiscal policy in 1981, Chancellor Schmidt gave priority to the reduction of fiscal deficits over demand stimulation of the economy, but he did not find the full support of his party in this endeavor. Otto Lambsdorff, the FDP Minister of Economics at this time, explained in a now famous “U-turn” paper (Wendepapier) why he thought it was impossible to pursue the appropriate economic policies within the then government.13 This triggered the end of the SPD/FDP Government and the move of the FDP into a coalition with the CDU/CSU in October 1982. The disenchantment with the interventionist paradigm, which had set in already in 1980–81, was then endorsed by the 1983 elections. The new CDU/CSU/ FDP coalition won a majority on an economic platform committed to a more limited role for government and a greater reliance on market forces.

The new Government saw the lax fiscal policies of the previous years as the main problem. The increase in the share of government revenue, expenditure, and of the deficit in GNP in the course of the 1970s (see Table A15 in Chapter II) was believed to have deprived the private sector of the resources it needed to contribute to healthy economic growth and a reduction of unemployment. In addition, an overly generous social policy—with social transfers equivalent to 18 percent of GNP in 1982—was believed to have contributed to the high rate of unemployment by pushing up wage costs and suppressing incentives to work. Also, the micro-management of industry by the Government, through rules, regulations, direct subsidies, and incentives, was held responsible for structural rigidities in the economy and a general inability to adjust to the new international environment; these rigidities, which were seen as a broader European problem, were dubbed “Eurosclerosis.”14 In short, there was a widely held view that government interference in the economy had proved counterproductive and that it was necessary to “pare down the state to the core of its sovereign activities, which it will then be able to carry out all the more reliably.”15

The new economic strategy contained a number of implications for structural and fiscal policies. The task of structural policy was to attack the rigidities present in the economy with a view to speeding up adjustment. In particular, labor market rigidities that had increased significantly over the previous decade were to be eased; subsidies to ailing industries were to be curtailed; many areas of industry were to be deregulated; and important state enterprises were to be privatized. The task of fiscal policy was to “consolidate” the government finances and to pursue medium-term objectives—the Government was loath to set any targets on variables such as real growth, unemployment, or external balances and disavowed the stop-and-go policies of the past. There was a quantitative and a qualitative aspect to consolidation. The term “quantitative consolidation” meant the reduction of government expenditure, revenue, and the budget deficit relative to GNP; “qualitative consolidation” meant the reform of the tax system and a restructuring of government expenditure away from current spending toward investment. Given the complexity of the program, the politicians thought that a gradual implementation was appropriate. In the first step, the most detrimental rigidities in the labor market would be eliminated and government spending and budget deficits would be curtailed. This was expected to create more room for maneuver for both fiscal and structural policies so that, in the second step, the “qualitative” consolidation of government finances and the deregulation of the economy could follow.

During its first legislative period, the Government was indeed successful in improving the state finances. The share of general government expenditures in GNP declined from 49¾ percent in 1981–82 to 47 percent in 1986. This made possible a narrowing of the general government deficit from about 3½ percent of GNP in 1981–82 to 1¼ percent of GNP in 1986 and a lowering of the share of general government revenues in GNP from 46¼percent to 45½ percent over the same period. There was a significant cutback in social expenditures by the government as well; the share of these outlays in GNP fell from 17¾ percent in 1981–82 to 16 percent in 1986, despite a rise in the unemployment rate. Also, labor market legislation in 1984–86 limited the trade unions’ negotiating power in labor disputes, improved the conditions for the hiring of youths and part-time workers, and increased the flexibility of labor contracts.16

Relatively little progress, however, was made in the areas of qualitative consolidation of government expenditures, privatization of state enterprises, and deregulation of the economy. Contrary to the authorities’ intentions, the share of subsidy payments in total expenditures increased from 3¾ percent to 4½ percent between 1981–82 and 1986; only a small part of the privatization program was carried out; and the process of deregulation was slow.

On the other hand, soon after some progress in quantitative consolidation became visible, the objective of reducing and reforming taxes gained momentum. In 1985, a DM 20 billion (1 percent of GNP) tax reform package was enacted. It was aimed chiefly at providing relief for families with children and at reducing marginal tax rates and it was to be implemented in two parts: DM 11 billion from 1986 and DM 8½ billion from 1988. After being returned to office in January 1987, the ruling coalition agreed upon a larger package of tax reform and reduction (coupled with a reiningback of tax preferences) that became fully effective in 1990 (see Table A16 in Chapter II).

International Concerns: Tackling the External Surplus

A prominent feature of the present economic upswing in the FRG has been the emergence of a large external surplus. This was the result, first, of export-led growth in 1984–85 and, second, of the large terms of trade gains in 1986–87 in the wake of the appreciation of the deutsche mark and the fall in oil prices. Following the Plaza Agreement in the fall of 1985 in which the Group of Five countries committed themselves to work toward a controlled depreciation of the U.S. dollar, greater pressure was put on the FRG to adopt policies that would boost domestic demand. An expansion of domestic demand in countries with external surpluses was considered desirable to take up the slack in the world economy that was expected to result from a reduction in U.S. net imports. These considerations temporarily influenced the conduct of economic policy in the FRG.

In 1986–87, fiscal policy turned expansionary, though this was more the result of the tax reform already enacted than a response to international pressures. The response of fiscal policy to the macroeconomic environment was, however, more evident in decisions taken in 1987–88. At a meeting of the Group of Six in early 1987 (the Louvre Accord), the German authorities agreed to bring forward DM 5 billion of the tax cuts envisaged for 1990 to 1988, raising the size of the tax cut already scheduled from DM 8½ billion to almost DM 14 billion (¾ of 1 percent of GNP). This, it was thought, would help bolster domestic demand and contribute both to stronger growth and a more rapid reduction of the current account surplus. Against the backdrop of turbulence in financial markets in the latter part of 1987, the Federal Government decided in December 1987 to take further fiscal action to support economic growth. The measures included additional loans to municipalities and medium-sized enterprises and an increase in investment by the Federal Postal System. Later, in January 1988, when confronted with an unexpected shortfall in revenues due to lower-than-expected profit transfers from the Bundesbank and higher-than-envisaged transfers to the European Community (EC) budget, the Government decided not to take offsetting measures and to tolerate a temporary rise in the deficit. As a result of these decisions, the federal deficit widened, from its narrowest point in 1985, by almost DM 13 billion to DM 36 billion (1¾ percent of GNP) in 1988. Deficits at the other levels of government rose too: thus, the general government deficit increased to DM 45 billion (2 percent of GNP).

The expansionary fiscal policy stance, combined with an accommodating monetary policy, contributed to rapid growth of domestic demand in 1986–88. The progress in external adjustment, however, was limited. The reduction in the real external balance that took place in 1986–87 was more than offset by improvements in the terms of trade, so that the external current account surplus increased substantially. When the terms of trade stabilized in 1988, real exports rebounded and prevented the current account surplus from declining.

On the Eve of GEMSU

In 1989, fiscal policy returned to the consolidation of government finances. A DM 8 billion increase in indirect taxes, enacted in 1988, together with fiscal drag, resulted in a negative fiscal impulse from the revenue side. This contractionary impulse was reinforced by a withdrawal of stimulus from the expenditure side at the general government level as the savings from a reform of the health system more than offset higher expenditures of the territorial authorities. As a consequence of this and the buoyant economy, the general government accounts showed a surplus for the first time in 15 years; the deficit of the territorial authorities declined to its 1985 level; and the federal deficit fell to its lowest point during the present upswing. Thus, following slippages in 1986–88, quantitative consolidation seemed to be back on track. The prospect of somewhat higher deficits in 1990 did not imply a permanent weakening in the quantitative consolidation effort since the increase in deficits was expected to be temporary and reflected a major step toward qualitative consolidation of government finances. 17

Progress in the area of qualitative consolidation, on the other hand, continued to fall short of the Government’s objectives. There were achievements in tax reform, privatization of federal government holdings in private industry, reform of the public health and pension insurance systems, and in reducing some of the rigidities in the labor market. Further reforms in business taxation18 were also planned, but in other areas, such as privatization,19 subsidy reduction,20 and deregulation,21 much remained to be done.

Against this background, the question arises as to what extent GEMSU will affect the future course of fiscal policy, in particular whether qualitative consolidation can be completed and how the goal of quantitative consolidation will be affected.

Fiscal and Structural Policies in GEMSU

From the fiscal perspective, GEMSU came at a very favorable time. Government finances in 1989 were in a strong position and several major fiscal reforms had been successfully implemented. As a result, there was scope for fiscal support of the economic unification process. While this was fortunate, there was also the danger that the by and large satisfactory state of government finances could invite overly generous fiscal support.

For 1990, budgetary decisions in the FRG were originally determined by the Government’s medium-term fiscal program that foresaw the implementation of the third and largest part of the three-step program of tax reform and reduction with effect from January 1, 1990 (see footnote 17). But the changing political and economic environment soon began to leave its imprint on fiscal policy.22 During 1990, the Bundestag enacted three supplementary federal budgets primarily aimed at supporting the economic unification process; additional borrowing related to east Germany totaled some DM 33 billion. Moreover, the Federal Government and the Länder established an extrabudgetary fund (German Unity Fund) with a total endowment of DM 115 billion to provide assistance to the GDR Government in 1990–94.23 Of the total, DM 95 billion would be raised in the capital market (including DM 20 billion in 1990) and DM 20 billion would come from the federal budget.24

As the economic integration of the two economies proceeds, additional pressures on government budgets seem likely. Many of the requests for government assistance will be justified with the need to support economic adjustment in east Germany.25 However, as the experience in the FRG during the 1970s and 1980s has demonstrated, there is the risk that financial support for economic adjustment tends to extend the adjustment period and in the event to become entrenched.26 The experience of the 1950s and 1960s, on the other hand, suggests that adjustment can occur quite efficiently when the Government limits its involvement in the economy.

The following points seem to be of particular importance. First, rapid economic adjustment and growth can be successfully achieved without subsidies to industries—in 1955, real per capita GNP growth reached a high of 10½ percent, while subsidy payments reached a low of only ¼ of 1 percent of GNP, one tenth of their level of the mid-1980s. In fact, as the experience in later years has demonstrated, subsidies may well be counterproductive because they reduce the pressures for adjustment and thus tend to preserve existing economic structures. Second, although a social safety net is important to increase the public acceptance of economic restructuring, care should be taken to limit the adverse effects of social transfers on the flexibility of the labor market. It is noteworthy that in 1955 social transfers relative to GNP amounted to only a little more than two thirds of their 1985 value. Third, policymakers should be careful that the pursuit of equity through the tax system is balanced against efficiency losses that might ensue. Direct taxes, which have grown markedly since the 1950s, may, if excessive, seriously impair work incentives. However, in interpreting the experience of the 1950s, one needs also to bear in mind that circumstances and expectations at that time differed substantially from those that now constitute the environment for GEMSU.

The question arises: Should fiscal policy be used to moderate some of the demand pressures emanating from GEMSU, including those related to budgetary assistance to east Germany? A review of the historical experience urges caution in using fiscal policy for demand management. The problem lies not so much in the principle of demand management—indeed, gains from well-designed and timely policies are likely—but rather with the practical problems of implementation. There is, of course, the usual problem of timing—because of lags in implementation, policies designed to be anticyclical can turn out procyclical—this was evident from the experience of the FRG in the late 1970s. Moreover, even when implemented, there can be significant lags before policies have their full effect—evidence presented in Chapter IX indicates, for example, that the effect of increased government saving on national saving may be offset to quite a large extent by reductions in private saving, at least initially. But more fundamentally, there is a danger that the measures used to achieve stabilization objectives have long-run adverse effects on the structure of the budget and the allocation of resources in the economy: the microeconomic effects of tax and expenditure changes may not be given much attention in the face of pressing stabilization objectives, and tax changes which generate revenue initially for stabilization purposes can, in the long run, fuel ill-considered expenditure programs.

In the event that fiscal measures are needed to offset some of the expansionary effects of GEMSU, the first priority should be to take actions that were already warranted on microeconomic grounds before GEMSU. In the case of the FRG, there are a number of government subsidy programs that fit into this category, including those related to the “costs of division.” In 1990, the territorial authorities are estimated to support West Berlin and the areas negatively affected by the inner-German border by about DM 27 billion in the form of transfers and tax exemptions (DM 13 billion in direct transfers from the Federal Government to the West Berlin budget and DM 14 billion in subsidies for enterprises and workers active in Berlin and the other areas).27 Clearly, with the lifting of the inner-German border, the rationale for this support will disappear. The phasing-out of these tax preferences and transfers would go part of the way toward financing the integration of the east German economy into the expanded Federal Republic. There are, moreover, numerous other subsidies and transfers the reduction of which would make economic sense even without GEMSU.

Considerations outlined above suggest that the Government should be very cautious in tailoring new taxes simply to the financing needs of GEMSU: if new taxes are unavoidable, they should, at least, be consistent with the Government’s ongoing tax reform program. Moreover, to the extent that the adverse effects of GEMSU on government finances are projected to be temporary, it might be unwise to allow revenue increases to become embedded in the fiscal structure. However, a tax measure perceived as temporary may result in a particularly large offset in private saving behavior.

The case against a tax increase in the FRG rests on the rise in the deficit being limited and temporary and the spillover effects of rapid demand growth in east Germany remaining manageable. It is clear, however, that the outlook for the government finances in east Germany is highly uncertain and that one could envisage large fiscal imbalances being sustained for some time. It may also turn out that past experience, on which model calculations of the effects of GEMSU are based, is a poor guide given the unprecedented character of the unification process. These factors argue for a close monitoring of developments in Germany and their international effects. Should persistent and sizable fiscal imbalances seem likely, policymakers should be ready to take decisive action.


See Leslie Lipschitz and Thomas Mayer, “Accepted Economic Paradigms Guide German Policies,” IMF Survey (Washington), November 28, 1988, pp. 370–74.


See, for example, Thomas Mayer and Günther Thumann, “Radical Currency Reform: Germany, 1948,” Finance & Development (Washington), March 1990, pp. 6–8.


In a paper written in 1943–44 (“The Economic Needs of Postwar Germany”), Erhard emphasized the role of the private sector in the reconstruction effort as follows: “the State’s economic power and initiative are bound by strictly circumscribed limits so that trade and industry will be largely left to their own devices in finding ways of providing a new basis for Germany’s economic life by establishing a new gross national product. The private sector of the economy will enjoy a fresh opportunity to demonstrate its skill and it must seize this opportunity in order to refute the criticism sometimes directed against it. Entrepreneurs will once more have to resolve the problem of producing for a market without any purchasing power i.e. devoid of sure sales.” See Standard Texts of the Social Market Economy: Two Centuries of Discussion (Stuttgart; New York: Gustav Fischer, 1982), p. 7.


Walter Eucken, in an essay written in 1952 (“A Policy for Establishing a System of Free Enterprise”), described this policy in the following words: “The fundamental principle not only calls for abstinence from certain economic acts such as government subsidies, the establishment of mandatory State monopolies, a general freeze on prices, prohibitions of imports etc. Nor is it enough simply to prohibit cartels, for instance. The principle is not primarily negative in nature. There is, rather, a need for a positive economic policy aimed at developing the marketing structure of unrestricted competition and thus at realizing the fundamental principle. This is also a field in which the competitive system differs entirely from the policy of laissez-faire, which in substance did not admit of any positive system of economic regulation.” Ibid. p. 116.


In 1944, in “The Guiding Principles of the Liberal Programme,” Wilhelm Röpke wrote, “If left to itself, a market economy is dangerous and indefensible because it reduces people to a thoroughly unnatural existence which they then cast aside together with the free market which has become hateful. In other words, the market economy requires a firm framework, which we may conveniently refer to in short as the anthropological-sociological framework. If this framework breaks down, then it is no longer possible to have a free market. In other words, market economy is not everything. It has a special place in a healthy and efficient society where it is indispensable and where it must remain pure and undiluted.” Ibid. p. 190.


In 1947, Alfred Muller-Armack spelled out the theoretical foundations of the social market economy in “The Social Aspect of the Economic System” as follows: “We would therefore be well advised to look for a new system which will harmonize both the social aims of our time and the most fundamental tenets of business practice and the science of political economy. Such a synthesis can only be achieved by the re-establishment of a genuine market economy. This new market economy must distinguish itself from the liberal market economy of the 19th century which, like the system of central control, is a thing of the past, by virtue of its social objectives. We must build a ‘Social Market Economy’.” Ibid. p. 17.


In the mid-1960s, for example, a major battle took place within the so-called Grand Coalition between the CDU/CSU and the SPD over the question of a revaluation of the deutsche mark. The SPD, led by Karl Schiller, the Minister of Economics, argued that a revaluation was needed to dampen inflationary pressures caused by the sizable balance of payments surpluses. Chancellor Kiesinger (CDU) rejected the request. The exchange rate remained unchanged until the end of the 1960s when a new SPD/FDP government was elected.


Karl Schiller, “Konjunkturpolitik auf dem Wege zu einer Affluent Society,” Kieler Vorträge No. 54 (Kiel, 1968), p. 8 (translated).


Schiller gave the following characterization of the Stability Law: “The tool box of demand management possibilities provided by this law is indeed extraordinarily rich; in fact, it is probably the most modern tool box available. But … this law is not a panacea. It provides … instruments to counter a recession or dampen an overheating of the economy. But it does not, for instance, provide instruments to boost unsatisfactory economic growth.” See ibid., p. 9 (translated).


The tax regulator was used in 1970 and 1971 to raise DM 2¼ billion and DM 3¾ billion, respectively, in additional taxes to withdraw stimulus from the economy. Of this, DM 5¾ billion was repaid in 1972 and DM ¼ billion in 1973, shortly before the rise in oil prices triggered a recession.


After deficits in 1967–68, the federal budget ran surpluses in 1969—70 when economic activity was strong (see Chart 11 in Chapter II).


Schiller, who became “Super” Minister of Finance and Economics in 1971, resigned in 1972 mainly because he was concerned about this inability to control deficits in the aftermath of cyclical downturns and recoveries.


O. Lambsdorff, “Konzept für eine Politik zur Uberwindung der Wachstumsschwäche und zur Bekämpfung der Arbeitslosigkeit”(mimeographed; Bonn, 1982).


See, for example, Herbert Giersch, “Eurosclerosis,” Kiel Discussion Papers No. 112 (Kiel, 1985).


See Bundesministerium für Wirtschaft, Jahreswirtschaftsbericht 1987, p. 21 (translated). In December 1985, the Federal Ministry of Finance described the role of fiscal policy in more detail: “In an economic system based on free enterprise, economic growth is not so much the aim as the result of market processes. The task of the public sector is not to realize the highest possible growth rates at the cost of unwarrantable fiscal policy measures, but to ensure that economic activity can develop unhindered and is provided with sufficient incentive. The price signals transmitted by the market must reach the recipients … with as little distortion as possible. Sound public finances will increase the confidence of markets in the dependability of policies. Well-ordered public budgets are thus an important basis for long-term decisions … and part of the foundation of an efficient free-market system.” See Bundesministerium der Finanzen, Tasks and Objectives of a New Fiscal Policy: The Limits to Public Indebtedness (1985), p. 19.


For more information on this and the following see Leslie Lipschitz and others, The Federal Republic of Germany: Adjustment in a Surplus Country, IMF Occasional Paper, No. 64 (Washington: International Monetary Fund, January 1989).


On January 1, 1990, the third step of tax reform took effect that included an estimated reduction in income taxes by DM 39 billion, coupled with a reduction in tax preferences equivalent to DM 14 billion (Table A16 in Chapter II). The tax reform package of 1990 thus implied a net tax cut of DM 25 billion, bringing total net tax relief granted in the 1986—90 tax reform program to about DM 50 billion (2½ percent of GNP). For a more detailed discussion of the tax reform see Lipschitz and others, ibid.


Although tax reform provided some tax relief for businesses (inter alia through a reduction of the top marginal rates of income and corporation taxes), the Government intended to implement a business sector tax reform in the next legislative period in time for the completion of the EC internal market at the end of 1992.


The Federal Government had completed its privatization program but little privatization had occurred at the state and municipal levels.


In 1989, subsidy payments as defined in the national accounts still stood at 2 percent of GNP, slightly above their level of 1982. Subsidies of the territorial authorities as defined in the Federal Government’s biannual subsidy report stood at 3½ percent of GNP; federal subsidies alone were equal to 1½ percent of GNP. Despite the reduction of tax exemptions—a part of the 1990 tax reform package—federal subsidies were budgeted to decline by only 6 percent in 1990.


In the restructuring of the Federal Postal System that took place in 1989, the supply of some telecommunication services was partly liberalized. An initiative to liberalize shop-opening hours resulted in the possibility of an extension of opening hours by two and one half hours on each Thursday with an unchanged weekly maximum. Further deregulation activities still await preparation of a report by the Deregulation Commission (now scheduled for 1991). See footnote 55 in Chapter II for additional information on the Deregulation Commission.


See Chapter II, section on “Fiscal Implications of GEMSU.”


The prime purpose of keeping the bulk of transfers to the GDR offbudget was to facilitate continuation of the present system of financial relations between the Federal Government and the Länder, as well as between the Länder, until the end of 1994.


The contribution from the federal budget is expected to be financed by a reduction in “the costs of division” of Germany (see below).


There are significant incentives for investment in east Germany which are outlined in footnote 54 of Chapter III. In addition, the public Trust Fund (Treuhandanstalt) in east Germany has been given authority to borrow (in anticipation of revenues from privatization of government assets) to support the structural adjustment of east German enterprises. The borrowing authority was initially set at DM 7 billion in 1990 and DM 10 billion in 1991 and was subsequently raised to DM 25 billion over the period to end-1991.


A case in point is the coal mining industry where subsidies have been paid over many years. In 1988, subsidies per employee were estimated at DM 63,300 while labor costs per employee were DM 60,400. Total subsidies in 1988 were estimated at DM 12 billion (½ of 1 percent of GNP).


In addition, the territorial authorities are estimated to spend about DM 7½ billion and the social security system roughly DM 5½ billion to ease the consequences of the division of Germany.