The role of the state

Table of Contents

EXECUTIVE SUMMARY

LIST OF FIGURES

1 INTRODUCTION

2 THE ECONOMIC SYSTEM

3 OBJECTIVES OF ECONOMIC POLICY

4 INSTRUMENTS OF ECONOMIC POLICY

5 THE ROLE OF THE STATE IN LABOUR MARKET
5.1 Economic situation on German labour market
5.2 Reasons of Unemployment
5.3 Economic Assessment of governmental instruments
5.3.1 Wages
5.3.2 Labour time
5.3.3 Dismissal protections

6 CONCLUSION

BIBLIOGRAPHY

ITM-CHECKLISTE

List of figures

Figure 1: Governmental objectives

Executive Summary

The German labour market is one of the four key determinants of economic welfare. In this paper the role of the state and the state acting on the labour market will be discussed. Firstly it will be shown, which assignment has been given to the state within the German law. Secondly the instruments of monetary and fiscal policy will be shown as well as individual governmental activities, which have impact on the German labour market. In a further step, current governmental activities will be assessed whether they are able to decrease unemployment or not. In particular, it will be shown that instruments increases overall economic demand, reducing labour time or regulating labour market do not lead to increased economic welfare but increasing unemployment.

1 Introduction

Today’s economy is characterized by unemployment, recession, a fluctuating level of prices, varying social needs and other negative aspects on citizens. Nowadays govern- ments play an important role in the economy.¹ Governments spend huge parts of their Gross Domestic Product for social transfers or individual subsidies.² Expressing solidarity among the citizens governments try to redistribute income from “the lucky ones” to the “needy ones”. The state tries to achieve social and economic objectives, which help the citizen within the economic process. Due to socio-political reasons the autonomous mar- ket process is corrected by the state.³ The state also acts as a big consumer to purchase buildings, to construct roads, railways and to employ public employees. To effort all these performances the governments raise taxes, fees, charges or raise their level of debts. Like anyone else, the governments do have bounded budgets for their activities. This might often lead to a vicious circle. As more debt means more debt service the need to borrow more money is evident. Most governments are currently indebted to foreigners or to the private sector. This consequently leads to extensive savings that have impact on socio-political objectives by the state. All these activities must be very well balanced. These instruments are highly observed by the German publicity whether these instru- ments achieve a growth in economic welfare or not.⁴

This assignment looks at the economic role of the state in Germany and how it fulfils its tasks. The objective of this assignment is to show the role of the German state, it’s socio- political objectives and the possible instruments, which might be used to achieve its ob- jectives. Due to the complexity of possible actions by the state, the impact of particular instruments on the German labour market will be shown and discussed if they lead to de- sirable results.

2 The Economic System

From the institutional economic perspective the Economic System includes formal and informal institutions with economic transactions. The transactions remit ownership and property rights and lead to transaction costs, which have an impact on economic events.⁵ The state’s objective is to administrate the distribution of these ownerships and these property rights. In other words, the state’s objective is to reduce rising transaction costs between economic units. The existing transaction costs should be relatively small within the economy. The more opposition against the Economic System the more transaction costs, that will have an impact on decreasing economic welfare.⁶

So, the Economic System represents the framework for all governmental and economical activities. Although the German constitution is neutral regarding the Economic System, there are plenty of rules, which favour a social market-economy. Due to several rules, the planned economy is considered as implausible. Rules like freedom of trade, private prop- erties or the right to built up unions refer to free market-economy.⁷ In Addition, the Theory of social market economy⁸ combines socialism and free market-economy. It was the at- tempt to bound unbridled capitalism and perfectly driven socialism by competition and individual initiatives by the citizen. The effects, which increased the welfare, should be utilized to finance social compensation within the Economic System.⁹ Within the social market-economy the state only adopts the administrative function to provide minimalistic conditions.¹⁰ The state should implement a working legal system, which allows the eco- nomic units to act within default rules. Furthermore the operativeness of the market can only be guaranteed with further conditions like a working monetary system. And to avert inequity the state redistributes the outcome of the market “fairly”.¹¹ Although these func- tions have impact on the economy, the state is not supposed to act as an economic unit itself.

Nowadays the state is not limited to global actions but acts selective and affects special economic sectors like mining, shipbuilding or the steel industry. In the present day the social market-economy is not understood as the economic framework but as pro-active engagement of the state into the economic cycle.¹²

3 Objectives of economic policy

Many Countries define freedom, security and justice as central social basic values within their community.¹³ These basic values are often implemented in constitutions or laws.¹⁴ Freedom, security and justice condense within the top social objective: the maximization of welfare. The enhancement of economic welfare can be understood as the operational definition of the social basic value of communities.¹⁵

In the German Federal Republic the realization of enhancing the economic welfare was established by the “Gesetz zur Förderung der Stabilität und des Wachstums der Wirtschaft” in 1967.¹⁶ The objectives for governmental activities are presented in §1: "Bund und Länder haben bei ihren wirtschafts- und finanzpolitischen Maßnahmen die Erfordernisse des gesamtwirtschaftlichen Gleichgewichts zu beachten. Die Maßnahmen sind so zu treffen, dass sie im Rahmen der marktwirtschaftlichen Ordnung gleichzeitig zur Stabilität des Preisniveaus, zu einem hohen Beschäftigungsstand und außenwirtschaftlichen Gleichgewicht bei stetigem und angemessenem Wirtschaftswachstum beitragen.“¹⁷

Figure 1 shows the different objectives stated in the “Stabilitätsgesetz”. The main objective is welfare maximizing.

In addition, other objectives have to be fulfilled, which are implemented in further laws. The “Gesetz über die Bildung eines Sachverständigenrates zur Begutachtung der gesamtwirtschaftlichen Entwicklung" posits the improvement of income and capital.¹⁸ An- other objective is the environmental protection, which was included in the German consti- tution. Art. 20a implies the protection of the natural fundamentals of life in response to upcoming generations.¹⁹ Besides this, international objectives come into focus too, such as the treaty establishing of the European Community.²⁰

illustration not visible in this excerpt

Figure 1: Governmental objectives

One of the major objectives within the “Stabilitätsgesetz” is the price stability²¹. Due to the negative effects of inflation Price Stability plays an important role. The aim of Price Stability is to compensate price reductions and increment in prices so that the average of prices does not fluctuate. The Governing Council of the European Central Bank defines Price Stability as an increase in consumer prices for the Euro area of below 2% on a annual.²² It will be measured by using the method of the HICP²³.

In the beginning of the 20th century large-scale unemployment was the consequence of worldwide economic crisis. Since these times, the economic objective of Full Employment is permanently in political discussion and debates.²⁴ Unemployment leads to a reduction in economic welfare and leads to inequality within the individual distribution of income. Due to decreasing revenue and increasing expenditures, a high rate of unemployment takes tremendous effect on federal budgets. The economic objective of full employment will be measured by the employment office and is defined as the ration between the un- employed population²⁵ and the labour force potential. The causes of unemployment can be partitioned into structural²⁶, cyclical²⁷, seasonal²⁸ and frictional²⁹ unemployment.

Beside safeguarding the national supply with private and public goods, the core objective of the state is to increase economic wealth. The economic growth is measured by the Gross Domestic Product or the Gross National Product. The Gross Domestic Product de- scribes the value of production within a country’s boundaries. The Gross National Product includes the economic performance by all German inhabitants. So it covers international revenues as well.³⁰

The appropriate growth implies that the growth rate should be sustainable. Appropriate growth can be interpreted to deny short-term welfare maximization to the benefit of longterm welfare maximization.³¹

The allocation of resources and the stabilisation of the national economy will be affected by international transaction. The dimension of these integrations will be represented by the Balance payments. The Equilibrium of Foreign Trades and Payments describes a situation of international relationship, which has no negative impact on national economy. The Equilibrium exists when the national economy neither imports inflation, recession or unemployment from international markets nor national economic crises will be solved at the expense of foreign countries.³²

4 Instruments of economic policy

Knowing the economic objectives the state has different instruments to obtain these ob- jectives. The choice of appropriate instruments is left to the state.³³ To achieve these ob- jectives the state can e.g. use monetary politics, financial policy or direct interference.³⁴

The monetary politics include money supply as well as adoptions of interest rates. The monetary politics is executed by the European Central Bank and the European System of Central Banks who are also bounded to the economic objectives. Controlling the money supply, the European Central Bank tries to regulate the appropriate amount of money available within the economic cycle. Influencing the interest rate has also impact on the amount of money available. By reducing or increasing the available money supply or the interest rates the European Central Bank is able to slow down the circulation of money and the granting of loans, which have a positive impact on inflation and economic growth.³⁵ With the instruments of fiscal policy the state tries to act on the economic cycle. Fiscal policy is part of the stabilisation policy, which have impact on the economy. These voluminous instruments to affect different components of demand allow the fiscal policy a wide range of possibilities to affect on unemployment and on economic cycle.³⁶ These instruments can be divided into instruments that relate to revenues, expenditures or debts.³⁷ By fixing the governmental budgets, allocation and distribution objectives can be followed. The state uses these instruments to absorb the shocks of the economic cycle. On the one hand, the state has to boost the economy during depression or recession and on the other hand the state has to slow down the economic boom to avoid increasing in- flation.³⁸ This Keynesian economic policy is called anti-cyclic economic policy.³⁹ While depression or recession appropriate instruments might be increasing financial helps for the federal states, decreasing taxes, additional payments in capital investments or expan- sion of fringe benefits.⁴⁰ These instruments have to be financed of economic reserves or debts. In times of a booming economy governmental revenues rise and existing debts may be refunded.⁴¹

To avoid monopolies or any restriction within the competition the state uses the regulatory policy.⁴² Until 1989 there has been a much regulated market for telecommunication prod- ucts in Germany. There have been many reasons for this regulation. Due to the high fix costs by implementing the telecommunication infrastructure, private firm were not able to effort the investments.

[...]

¹ Cp. Unknown (2004): Deutschland - ein Land im Umbruch, p. 961 - 962.

² For an overview of current Gross domestic product statistics cp.OECD (2006).

³ This already implies a kind of assessment of the autonomous market processes. This will be explained later on.

⁴ Cp. Unknown (2006): Deutsche Lohnkosten weltweit auf Platz drei; Wefers (2006); Münchau (2006); Schiermeyer (2006); Sommer (2006).

⁵ In the dimension of the new institutional economy, economical actions are not technical processes only but transactions between individuals. Transaction costs include search- and informationcosts, bargain- ing costs and Policing and enforcement costs. Cp. Klump (2006), p. 176. For further information about new institutional economics cp. Richter/ Furubotn (1999); Baron/ Kreps (1999); Williamson (1993).

⁶ Cp. Klump (2006), p. 197.

⁷ Cp. Altmann (2000), p. 13.

⁸ Originally the term “Soziale Marktwirtschaft” was coined by Alfred Müller-Armach. Cp. Klump (2006), p. 192.

⁹ Cp. Klump (2006), p. 192.

¹⁰ Cp. Altmann (2000), p. 18.

¹¹ Cp. Woll (1996), p. 75.

¹² Cp. Altmann (2000), p.19.

¹³ Cp. Klump (2006), p. 246.

¹⁴ Cp. Art. 2 and Art. 3 Grundgesetz, which include free individual evolvement and equality of men.

¹⁵ Cp. Klump (2006), p. 247.

¹⁶ This target system is also known as the magic square, because it is almost impossible to reach those objectives simultaneously.

¹⁷ It is also known as "Stabilitätsgesetz“. Cp. Altmann (2000), p. 6.

¹⁸ Cp. Gesetz über die Bildung eines Sachverständigenrates zur Begutachtung der gesamtwirtschaftlichen Entwicklung (1963), §2.

¹⁹ Cp. Grundgesetz, Art. 20a.

²⁰ Due to the plenty of objectives the magic square expands. Cp. Altmann (2000), p. 7.

²¹ In the following assignment, the term Price Stability is used in accordance with the European Central Bank.

²² Cp. European Central Bank (2006), p. 34.

²³ The HICP is calculated and published by Eurostat and measures the Price Stability in the euro area by using the Laspeyres-Index. For further Information cp. European Central Bank (2006), p.31.

²⁴ Cp. Klump (2006), p. 258.

²⁵ Unemployed persons can be characterized by an age until 65, registered at the labour office, not dis- abled and looking for jobs with more then 18 hours. Cp. Klump (2006), p. 259.

²⁶ Workers laid off by declining regions or by declining industries.

²⁷ This describes unemployment due to general economic recession.

²⁸ This kind of unemployment describes the unemployed during periods between agricultural seasons, school breaks, touristical seasons etc.

²⁹ Frictional unemployment describes the the time when people move between jobs or into the labor mar- ket. Cp. Altmann (2000), p. 104.

³⁰ Cp. Klump (2006), p. 266. For further information about national accounting cp. Woll (1996); Mankiw (2004).

³¹ Altmann compares this postulation with a long-distance runner, who runs behind a short-distance run- ner, but later on overtakes. Cp. Altmann (2000), p. 46.

³² Cp. Klump (2006), p. 263.

³³ Cp. Felderer/ Homburg (1999), p. 159.

³⁴ Besides these instruments, the state can also use trade policy or development politics.

³⁵ Cp. Felder/ Homburg (1999), p. 160.

³⁶ Cp. Klump (2006), p. 151.

³⁷ Cp. Altmann (2000), p. 320.

³⁸ Cp. Machold/ Friedrich (2006), p. 4.

³⁹ Besides this concept, there are other concepts as well. The concept of economic cycle neutral budget- ing bases on measures indicated by economic impact. Another concept is zero-base-budgeting. Zero- base-budgeting tries to structure the public budgets from the very beginning. It does not indicate any values from the past. Every expenditures and revenues will be completely checked once a year. Cp. Altmann (2000), p. 322.

⁴⁰ Cp. Altmann (2000), p. 325.

⁴¹ For further information about the economic cycle see Gärtner (2003), p. 34 et seqq.

⁴² Cp. Klump (2006), p. 63.