The German Miracle vs. the Welfare State

First Published: 2012-07-24

Published by the Ludwig von Mises Institute and reposted here with their kind permission. Read the original article at here…

[Chapter 12 of Prosperity Through Competition, 1957]

Every time I speak on the theme of "social security" I am in danger of being accused of going beyond my brief. If I may speak less as minister for economic affairs and more as a political economist, it will seem natural to those knowing the subject that within the sphere of the social market economy the minister for economic affairs has every reason to interest himself in further developments of our social policy. The social market economy cannot flourish if the spiritual attitude on which it is based — that is, the readiness to assume the responsibility for one’s fate and to participate in honest and free competition — is undermined by seemingly social measures in neighboring fields.

If one is prepared to think this problem through, one will understand the unwisdom of drawing the limits of discussion too narrowly. A watertight division could only be defended if the actions of all those influencing economic conditions stemmed from a common attitude, if they supported without reservation that order that the market economy wants to bring about. Put briefly, all would have to pull in the same direction.

I have repeatedly stressed that I consider personal freedom to be indivisible. With this conviction I have worked since 1948 to reduce all economic restrictions. A free economic order can only continue if and so long as the social life of the nation contains a maximum of freedom, of private initiative, and of foresight.

If, on the other hand, social policy aims at granting a man complete security from the hour of birth, and protecting him absolutely from the hazards of life, then it cannot be expected that people will develop that full measure of energy, effort, enterprise, and other human virtues that are vital to the life and future of the nation, and that, moreover, are the prerequisites of a social market economy based on individual initiative. The close link between economic and social policy must be stressed; in fact, the more successful economic policy can be made, the fewer measures of social policy will be necessary.

It should not be denied that in modern industrial countries even a good economic policy will have to be complemented by social-policy measures. On the other hand it is true to say that every effective social aid will have to be based on an adequate and growing national income, which means an efficient economy. Thus it must be in the interest of every organic social policy to secure an expanding and sound economy, and to take care that the principles guiding this economy are maintained and extended.

As a result of the transfer of incomes through social budgets, which today play an important role in the process of economic distribution, there is now a close interdependence between economic and social policy. A national economic policy of neutrality and autonomy is thus a thing of the past. It has to make way for a social policy that is closely tuned to economic policy. Social policy must not damage national economic productivity even indirectly, and must not run counter to the basic principles of the market economic order.

If we desire to guarantee a permanent free economic and social order, then it becomes essential to achieve freedom with an equally freedom-loving social policy. That is why, for example, it is contradictory to exclude from the market economic order private initiative, foresight, and responsibility, even when the individual is not in a material position to exercise such virtues. Economic freedom and compulsory insurance are not compatible.

Other special relations between economic and social policy will be mentioned later in more detail. Here it should be noted that any social policy that does not regard the stabilization of the currency as of first importance must create the greatest dangers for the social market economy.

The Hand in the Neighbor’s Pocket

This danger must be energetically countered. More differences of opinion exist on this point than on any other problem. Some say that the happiness and well-being of the people are based on some form of general solidarity, and that one should progress along this path at the end of which, of course, stands the power of the state. The calm and comfortable life so pursued might not perhaps be luxurious, but it would be all the more secure. This form of living and thinking is visibly expressed in the so-called welfare state. On the other hand the natural efforts of the individual to be thrifty on his own account and to think of his future, his family, and his old age cannot be abolished — even if great efforts have been made indirectly to kill the human conscience.

In recent times I have frequently been alarmed by the powerful call for collective security in the social sphere. Where shall we get to and how are we to maintain progress if we increasingly adopt a way of life in which no one wants any longer to assume responsibility for himself and everyone seeks security in collectivism? I have drastically described this flight from responsibility when I said that if this mania increases we shall slide into a social order under which everyone has one hand in the pocket of another. The principle would then be this: I provide for someone else and someone else provides for me.

The blindness and the intellectual inertia that are pushing us toward a welfare state can only bring disaster. This, more than any other tendency, will serve slowly but surely to kill the real human virtues — joy in assuming responsibility, love for one’s fellow being, an urge to prove oneself, and a readiness to provide for oneself — and in the end there will probably ensue not a classless but a soulless mechanical society.

This process is particularly incomprehensible because, with the spread of prosperity and the growth of economic security, our economic basis becomes increasingly solid; the need to safeguard the achievements from all future dangers overshadows all other considerations. Here there exists a truly tragic mistake, for one meets with an apparent refusal to recognize that economic progress and prosperity based on effort cannot be combined with a system of collective security.

This call for security, which naturally must permit more state intervention, shows up the contradictions contained in this dishonest policy. If the words of these demands are reduced to a simple formula then what is being demanded is no more and no less than a lowering of taxation simultaneously with a greater demand on the public purse. Have the defenders of such a thesis reflected where the state is to find the power and the means to meet such demands which, taken one at a time, might be justified?

The Need for Security

In the final instance this way of thinking leads to utterly antisocial results. If the state refuses to sin against the currency, which would destroy everything so far achieved in reconstruction, then its purchasing power — whether in the form of social-service payments, credits, loans or subsidies — is limited to what has first been collected from its citizens in taxation. I regard a policy that allows the state to gather capital in this manner, in order to enable it then to make private loans, as utterly immoral.

Those who do not shrink from thinking this problem through will rapidly recognize that the quest for security is an illusion. Just as a people cannot consume more than it has first produced, so the individual cannot gain more real security than we, the whole people, have gained as a result of our efforts. This basic truth cannot be concealed by attempts to veil it with collective schemes. It is for just these well-intentioned ventures that a high price has to be paid. Efforts to free the individual from too much state influence and too much dependence on the state are thus brought to naught; the tie with collectivism becomes stronger. The apparent security, granted to the individual by the state or by any other group, has to be bought dearly.

Whoever wants protection of this kind must first pay in cash.

It is also wrong to believe that we should only move toward a welfare state when collective security is granted by the state either completely or in part from general taxation. Nor can these dangers be avoided by imposing a comprehensive compulsory insurance, in which payments are financed from contributions. General compulsory insurance — whether it is fed from one source or from many — is only different in degree, not in principle, from the ordinary citizen’s pensions. The trend toward a welfare state begins when state compulsion extends beyond the circle of the needy, to include people who as a result of their position in economic life consider such compulsion and dependence as unwarranted.

Here the important question must be asked: Does penetration by the state, by the public authority, and by other large organizations into human life, and the resulting budgetary increases, accompanied by greater demands for taxation of the individual, does all this really lead to the greater security of the individual, to an enrichment of his life and to a decrease of individual anxiety? If I put this question in this absolute form, I should like to answer it equally clearly in the negative. The security of the individual, or at least his feeling of security, has not increased with the state or the group assuming a larger share of the responsibility; it has decreased.

And Finally the "Subject"

The just demand to give more security to the individual can in the end only be met by increasing general prosperity, thus instilling the feeling of human dignity and, with it, the certainty that the individual is independent.

The ideal I cherish is based on the strength with which the individual can say, "I want to prove myself by my own efforts; I want to meet the risks of life myself; I want to be responsible for my own fate. You, the state, must see to it that I shall be in a position to do so."

The cry must not be "You, the state, come to my aid, protect me and help me," but the other way around: "Don’t bother with my affairs, but give me sufficient freedom and leave me enough from the results of my labors so I can shape my own existence, and that of my family."

The result of this dangerous road toward the welfare state must be the increasing socialization of incomes, the growing centralization of planning, and the extensive tutelage of the individual with increasing dependence on the state or the group — together with the deterioration of a free and well-functioning capital market as an important prerequisite for an expansion of the market economy. In the end we shall find the subject and a guarantee of social security by an all-powerful state, but we shall also have a paralysis of the economy.

It seems to me to be particularly dangerous to make way for these tendencies toward a welfare state at a time when the objectives, or the material facts, are clearly all against such a trend. If we had to presume that in the modern national economy, in spite of the progress in technique, economic trends and the living conditions of the people are becoming worse, then this longing for complete collective security would be understandable. But it seems to be almost certain that the living conditions of the people who realize the true market economy will continually improve. Since we should count on rising incomes and a rising standard of living, from a social point of view it seems proper to ask the individual to increase his responsibilities accordingly. This demand is all the more justified since the welfare state, from all existing experience, means everything but "welfare" and must finally spell "poverty" for all.

This fundamental discussion about questions that cannot be avoided in an analysis of social policy does not mean that I wish to ignore the special requests that have recently been made. As the reader turns over these pages, social reform will probably have found its legal expression. Nevertheless, I am doubtful whether the discussion about the aims of social reform will have ended. A glimpse at those countries that in recent years have made similar attempts shows to what extent such reforms have become no more than the starting point for the achievement of a sensible social order. My criticism about the disastrous pressure for a welfare state must not be misunderstood as a wish to change social security, as we know it. I believe that a further extension of social security is perfectly possible. But what I consider as totally wrong is that people who, having acquired freedom as a result of their profession and their position in the national economy, should wish to move into a collective scheme, or worse still, to be pushed into it.

Limits of Social Insurance

In judging social insurance in its contemporary setting it should be remembered how much economic forms and principles have changed in the past decades and to what extent the social and political structure has changed. The man of the "proletariat" who cannot provide for his own old age, or who does not want to provide and thus has to be protected by the state, will soon vanish if the present economic policy continues. Living conditions for the worker have improved infinitely and have become freer since the era of Bismarck. Compulsory state protection should end where the individual is in a position to provide for himself and his family on his own responsibility. For wage earners, this applies at least to those who have a higher income and thus occupy a responsible position in the economy or in the administration.

Furthermore, it would be serious for our social life if such citizens were forced into insurance, for as a result of their position and functions it might be expected that they would want to prove themselves by their own efforts. It is perhaps understandable that war and currency reform, and the great changes that followed, have brought with them a demand for collective security. But it would now be wrong and ominous to base security from the general risks of life on such an eventuality, which it is to be hoped will never recur.

From what I have said it can be seen that I should like to limit the area of collective security rather than extend it. To avoid all possible misunderstanding it should be stressed that I regard it as a natural duty for the community to see to the security of those who are now old and who, through no fault of their own, have lost their savings as a result of policies leading to two inflations. Here no social differences exist; the old workers and employees have to be helped in the same manner as the members of the free professions, the independent workers, the natives and the refugees. But this special problem, arising out of Germany’s particular history, must not lead to that confusion which regards compulsory insurance and collective security as something that can be taken as a matter of course. The tragic consequences of inflation, experienced twice within one generation, does not tend to increase confidence in one’s own strength. These tragic experiences must be taken into account; but they should, on the other hand, lead to a more careful examination of all economic and financial measures to make sure that we do not again take the same path, which can only lead to a serious devaluation of our currency.

Attempts to include independent workers in collective insurance should be particularly scrutinized. A readiness to cope freely and responsibly with the hazards of life is essential to independence in a free economic and social order. Independence in the market economy means undertaking some useful job of one’s own accord and on one’s own responsibility, and thereby becoming a pillar of enterprise and initiative. On the one hand, the independent individual has open to him all the chances arising from economic progress but, on the other, he must be ready to face the economic risks involved.

In no circumstances can such a position in economic life be guaranteed by the state under the system of the market economy. It must, above all, be earned anew day by day by economic achievement, by the readiness and the courage to face risks, and, above all, by a will to be individually responsible to shape one’s own life, if it is to have meaning. As a result, those who are independent within our economic and social order must also show responsible foresight for themselves in facing the risks of life.

It is paradoxical and, moreover, an irresponsible privilege to give every citizen an opportunity to work independently and by means of a free economic policy to further the pursuit of independent living, and then to take away from these independent people by state compulsion the responsibility to shape their lives.

This compulsory insurance, which is essentially of the model type, loses sight of the fact that in the independent trades and free professions one deals with heterogeneous and differentiated groups, and that here, therefore, as a result of individual thrift, it becomes impossible to meet the needs of each case. A critical discussion cannot avoid the question of where it would lead if the free professions started — each group for itself — to build up a system of group provision.

No Out-of-Date Solutions

Have we not, in the past eight years, learned by tragic experience where it leads when the national economy is fragmented, in particular when every section and every class and every group believes that it can live its own life? If, for example, members of the free professions — be they doctors, lawyers, or accountants — want to cut themselves off in respect of their pensions, then this security within a smaller framework will become increasingly problematical. In this manner selfishness is cultivated, a damaging mania for the ego, so that this clannishness becomes simply out of date — especially as it is taking place at a time when we are beginning to free ourselves from protectionist and nationalist thinking and, in this way, to achieve wider horizons of individual and social life. It should not be thought that, on the one hand, tightly knit groups can find security in a collective scheme, and, on the other, can break their ties to move into a wider field.

From other aspects, too, such wrongheadedness leads to grave problems. For example, the attempt to apply the principles on which old-age pensions are based for workers and employees to individual professional groups must necessarily fail. It would be practical only if there were no chance of considerable structural changes during the next few decades. Even if for the mass of dependent workers a continuation of present trends can be expected, nobody can foresee how specific developments will affect certain of the middle-class sections: for example, craftsmen or retail traders. There, at least, the possibility of considerable structural changes has to be taken into account. The smaller the circle that wants to adopt the new principles of large-scale social insurance is, the greater the problems and the insecurity of the basis on which such an order is made will be.

These considerations must necessarily be relevant to the much-discussed pension reform, whether one speaks of an index pension, or a productivity pension based on wages, or of any other kind of pension. The decisive point is that the pension is meant automatically to change with the economic situation. This "movable" pension is based on the steady increase in productivity that is part of the market economy. It bases itself on the general experience that the increase in productivity is expressed less in lower prices than in higher nominal wages. Such a productivity pension related to wages is harmless only as long as no currency or economic disturbances result from wage movements. If these are expected, then this scheme to adapt pensions to wages increases the danger of upsetting currency stability. A cumulative effect may possibly be expected, the results of which will be discussed later.

A Good Social Policy Demands Currency Stability

From a political point of view some thought should be devoted to the question of whether too close a link with wages will not essentially lead to lower resistance to excessive demands from trade unions in wage negotiations. This connection is based more or less clearly on the equally dangerous and wrong precept that "the stability of the currency has nothing to do with social policy."

It seems to me in every respect impossible to base every new social reform, such as pension reform, on such a criminal catastrophe as the last inflation. It is a great mistake for a people, or a state, to believe that it can introduce and pursue an inflationary policy yet insure itself against the results. This is to try to lift oneself by one’s own bootlaces. On the contrary, it is essential to concentrate all efforts to prevent inflation, and to reject and so forestall it.

Inflation is not the result of a curse or a tragic fate but of a frivolous or perhaps even criminal policy. Every change in old-age pensions that brings about an inevitable rise in prices, thus reducing purchasing power, cannot lead to happy results. Larger groups of our people will want to escape from their responsibility to themselves, and will try to gain an apparently absolute yet quite illusory security.

To translate a wage policy (the so-called "active wage policy") that must result in permanently increased prices into the field of pensions must quickly reduce general support for currency stability and thus start a disastrous trend. A general interest in maintaining the real purchasing power of our money is one of the most important counterbalances that oppose an inflationary policy in a well-ordered state.

Furthermore, it must be asked how the formation of investible funds, so essential for technical progress, is to be achieved if social laws openly count on the likelihood of continually increasing prices. If all the people begin to lose confidence in the stability of the currency, and as a result of the aim for complete security demand such large contributions, then they would, in fact, have little or no incentive for individual saving.

During the discussions on the pensions index I clearly stated that it would be unwise to lay aside the idea of a movable pension. It is in favor of such a dynamically devised pension scheme that our idea of a minimum standard of living — that is, of a dignified way of living — is constantly changing. Pensions based on a full working life calculated on the classic contributory formula should, when pensionable age is reached, be regarded as insufficient — the more so, the stronger these changes are.

The real danger, the almost destructive effect of a dynamic pension, is to be found less in their mobility than in their being linked to wage trends, which may well exceed what can be combined with monetary stability.

On a modified basis there exists the possibility of a flexible adaptation of pensions to changing living conditions and standards. This would be the case, for example, if as a guide for such a pension scheme the current increase in productivity were taken. Then there would be a guarantee that even the pensioner participated in real progress.

The formula would have to be something like this: to the extent that the national income, at constant prices, divided by the number of the workers or the population, shows an increase in productivity, the basic pensions will be raised by the same percentage. The pensioner would then share in increased productivity, but his interests would constantly be directed — even during his active life — toward constantly improving the performance of the economy. This worker or employee (or pensioner) will not regard saving as superfluous, but will be aware of the fact that investments financed by savings serve to improve his well-being, and provide for his old age and for that of his family. As with an active man, so also the pensioner becomes a center of resistance to every attempt to pursue an inflationary policy.

In conclusion, it must be said that social security is certainly a good thing and desirable to a high degree, but security must first of all come from one’s own efforts and one’s own endeavors. Social security is not the same as social insurance for all — it is not achieved by passing individual responsibility to some group. At the start there must be responsibility for oneself, and, only where this is insufficient, the obligations of the state and the community begin.

For the benefit of our people it would be better if we showed less desire for collectivism and more social sense. The one kills the other. That is why finally the question has to be put whether, united by the wish and the obligation not to see any German exposed to want, we are acting rightly by strangling the best virtues in the ideal of collective security, or whether, by striving for greater prosperity, and by opening up more and better chances to gain personal prosperity, we should not declare war on the destructive spirit of collectivism. My own views are clear: I hope that my warning will not remain unheard.

Ludwig Wilhelm Erhard (1897–1977) was chancellor of West Germany from 1963 until 1966. He is notable for his leading role in the "German Miracle," West Germany’s postwar economic recovery: Erhard’s decision, as economics director for the British and American occupation zones, to lift many price controls in 1948, despite opposition from both the social democratic opposition and Allied authorities, and his consistent advocacy of free markets, helped set West Germany on its phenomenal growth path — an economic recovery to rapid growth and widespread prosperity in the 1950s. See Ludwig Erhard’s article archives.

This article is excerpted from chapter 12 of Prosperity Through Competition (1957), originally entitled "Welfare State: The Modern Delusion."


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