Why do you support the free market

State and economy

Hans-Jürgen Schlösser

To person

Dr. rer. pole. M. Sc. (LSE), born in 1952, is a university professor for economics and business didactics at the University of Siegen and head of the Center for Economic Education Siegen (ZöBiS). His work focuses on theoretical and empirical research on economic education, the concept of the economy as a human being, and regulatory and competition policy. Hans Jürgen Schlösser studied economics, education and philosophy at the University of Münster, the Kiel Institute for the World Economy and at the London School of Economics. Before he was appointed to the University of Siegen, he held professorships at the TU Chemnitz and the University of Koblenz-Landau.

Contact: [email protected]

In the social market economy, economic activity is largely coordinated by the market. However, when it comes to protecting public goods, for example, state intervention is appropriate. There are limits to both the market and the state.

Broker on the Sao Paolo Stock Exchange. (& copy AP)

Role of the market

In a market economy, also in a social market economy, the market is the first choice coordination instrument. The individuals coordinate their actions via markets, and only if this coordination leads to undesirable results should the state intervene: "As much market as possible, as much state as necessary" (Karl Schiller, Federal Minister of Economics 1966-1972). Market economy coordination of the individual economic actions means that the respective actors, especially the companies, are in competition with each other, that market prices are formed from supply and demand and that the individuals align their actions to these market prices. If, for example, the price of crude oil rises, this indicates in a market economy that this raw material has become scarcer, be it because stocks are declining or because consumption has increased. Market economy coordination means that, in such a case, companies and households try to use energy more rationally and avoid activities that are very consumption-intensive, and that companies try to develop alternatives to oil.

The central coordination mechanism that balances supply and demand in markets is therefore the price mechanism. It plays a central role in understanding markets. It provides important information between suppliers and buyers that they need to coordinate their business plans. Market prices are to be seen as a summary of the most varied of information, as "information aggregates", in which important variables such as production costs, transport costs, negotiation costs, and market power are included. The ability to correctly evaluate market prices is essential for any market to function. If individual economic subjects have to assess all this information separately from one another, their time would probably no longer be sufficient to draw up an economic plan at all. However, it is not necessary to evaluate a large number of individual pieces of information in order to be able to assess the scarcity of a good: market prices summarize all information in a single quantity. Their easy comparability enables economic agents to recognize trends in markets and to adjust to them.

Functions of the state

The individual plays a key role in the functioning of a modern economy. Just as important is how well it is possible to find the right distribution of tasks between the state and the market on the basis of individual decisions. According to the Scottish economist and philosopher Adam Smith (1723-1790), the pursuit of individual needs satisfaction results in the greatest benefit for society as a whole. He described this coordination effort - from the individual striving for benefit to the social optimum - with the metaphor of the "invisible hand" of the market, which does not require intervention by the state.

However, such an idealized economy with perfect markets does not exist in reality. Rather, market economies suffer from a number of inadequacies, including unemployment, income inequality and the exploitation of natural resources. So there are a number of good arguments for government intervention in economic life. However, there is disagreement about the optimal scope of government activity. In some economies the state takes on an almost unlimited number of tasks, while in others it is limited to certain areas.

What is socially just for one may be socially unjust for another. But even if the members of society could agree on a common understanding of social justice, the fundamental problem still exists that markets alone do not necessarily lead to an income distribution that is perceived as socially just. On the contrary, a perfectly functioning market can even result in an extremely unequal distribution of income, since under ideal conditions all buyers buy from the provider with the best price-performance ratio.

The magical square of economic policy
The 1970 Nobel Prize laureate in economics, Paul A. Samuelson, once cited the example in this context that the cat of the rich could end up drinking exactly the milk that the children of the poor lack. This happens because the market mechanism is driven by the purchasing power of the customer. Seen in this way, an efficient market system also needs correction. The point is to weigh the efficiency of markets and ethical and moral norms against each other and to make a decision that is as generally accepted as possible. From the point of view of economics, this includes, for example, dealing with the costs and benefits of various redistribution and transfer systems.

The short-term control tasks of the state in the context of economic policy are described and regulated in the Federal Republic of Germany in the Law for Stability and Growth of 1967, the "Stability Law". It obliges the government to simultaneously strive for four economic policy goals, the "magic square": price level stability, high employment, growth and external balance. These four goals are called "magical" because they cannot all be achieved at the same time. Rather, there are conflicts and interactions between the individual goals, so that economic policy measures to achieve one goal can have a negative impact on the realization of other goals. All four goals are described in more detail in the law, and the procedural instruments available to the state are also named. In this context, however, it is controversial whether delays in effect as well as information and knowledge deficits do not lead to the state destabilizing the economy with its policies, i.e. the opposite of what it wants to achieve.

One of the endeavors of commercial enterprises, which is supported by the state, is to ensure that the production factors labor, land and capital are used as productively as possible. The ultimate goal is to produce those goods that best meet the needs of consumers at optimal locations with minimal costs. This "allocation" task essentially relates to the three questions
  • What should be produced?
  • How should it be produced?
  • Where should production take place?
While many allocation tasks are best performed by the market, it fails when it comes to public goods. An important example of a public good is an intact environment. Taxes, subsidies, do's and don'ts belong to the state instruments of allocation policy. In terms of regulatory policy, the state intervenes to protect the natural environment if it creates the framework conditions for the formation of markets for emission allowances. This is the path taken by environmental policy to reduce carbon dioxide emissions under the "Kyoto Protocol".

EU structural policy
The state influences the allocation through structural policy when it supports individual economic sectors with subsidies in order to maintain them or to develop them faster than would happen in the market. Examples of conservation subsidies are coal mining and agriculture. The wind energy industry can be used to show how the state is trying to accelerate the development of a sector that is regarded as having a promising future. The European Union has pursued a particularly active structural policy with its structural funds in recent years because it wants to bring the economic level into line with subsidies to low-income regions and thus accelerate the growing together of the European states.

Critical voices against structural policy argue that it must be left to the market to decide which sectors grow or shrink. This criticism is particularly directed against conservation subsidies because they deprive growing sectors of resources.

In addition to stabilization and allocation, another state task in the social market economy is distribution in order to ensure more justice. The income distribution that the market has generated, the "primary distribution", is corrected for socio-political reasons in order to produce a more even distribution, the "secondary distribution". The main instruments that the state has at its disposal in the distribution task are the tax system and social benefits.

In addition to the allocation goals, regional and structural policy also pursues distribution goals, which are even in the foreground of the European Structural Funds. There are many conflicts in distribution policy. The most important conflict is that redistribution, which ultimately has to be financed through tax payments by households with higher incomes, dampens their performance motivation and at the same time deprives households with lower incomes who receive social benefits the incentive to help themselves.

Property rights

A market economy is only possible if the state defines and guarantees property rights. An example of unclear property rights was the unclear property claims in the former GDR shortly after German unification. Because it was not initially clear who could assert property claims, it was not possible to trade them or put them into productive use .

The most important right of ownership of a good is the right to use it for oneself. In this perspective, property rights to goods are traded on markets. The value of a good depends on the rights with which ownership of this good is attached: A car that you are always allowed to drive is worth more than a car that is banned from driving in the event of a smog alarm. The driving ban has a detrimental effect because it restricts property rights to the car. This decrease in value occurs even though nothing has been changed materially on the car.

Another important property right allows you to exclude someone else from using your own property. This right can only be exercised in the case of private goods, because the exclusion principle applies to them. For example, the owner of a house can prevent others from using it by locking the house. This does not apply to public goods such as clean air, because it is not possible to exclude someone from breathing the air, so that no individual, private property rights can be defined for public goods.

A third right of ownership entitles you to sell your own property. In addition, the fourth is the right to the fruits of use from property. In the economies of the Soviet Union and the GDR, it was allowed to own private property, for example a car, but it was generally forbidden to earn money with it, for example as a taxi operator.

Property rights must be guaranteed by the state. The parliament, the legislature, usually defines property rights in laws. The judiciary, the judiciary, interprets the property rights formulated by the legislature. Finally, the executive, i.e. government, administration and police, enforces property rights.