Models of the Market Economy
The core differences between the existing versions of the market economy in the
developed countries in the institutional structure of microeconomic activities of
government. Special scrutiny deserves the study of government intervention into the three
market functions - allocation of resources, creation of incentives for efficiency, and
distribution of income.
On this basis we may distinguish among three models
a)
the guided market economy stressing upon government involvement in
resource allocation (the Japanese case, for instance),
b)
the modified market economy giving a priority to incentives in
motivation (the US and UK economies), and
c)
the social market economy justifying intervention in income
distribution (Germany and Scandinavian countries, as an example).
This approach does not give any reasons for a classification of other models.
The Guided Market Economy
The Guided Market economy is based on the fundamental principles of the market
economy. However, it appeals for government intervention in resource allocation in order
to intensify economic development through the support of the most promising industries.
This means that priorities are raised and policies are developed to achieve the designed
goals in resource allocation and economic growth. In other words, the social preference
function of this model puts the desired resource allocation in the focus of the economic
system.
This priority determines the central place of the institution of resource allocation
that would provide guidance to industrial development and design industrial policies.
Industrial policy is a set of instruments and techniques designed to promote
economic growth on the basis of direct government participation in resource allocation
and industrial restructuring. From this perspective we distinguish two aspects of the
industrial policy:

Its macroeconomic aspect is associated with the role of government in raising the
economic potential of the country in the long run. It focuses on the quantity and
quality of production factors and particularly on human capital,

The microeconomic aspect of the industrial policy refers to the identification of
key industries and the promotion of their better access to resources and faster
growth.
The institution that develops the industrial policy and guides its implementation in
Japan is the Ministry of the Economy, Trade and Industry (METI). It develops goals and
instruments for industrial development and it is responsible for the flow of funds to
favored industries. However, these funds do not come from government. Plans for
economic development represent the consensus of big private business, government, and
academic community. In France, the role of METI is assigned to the General Planning
Commissariat (Commissariat General au Plan). While the Commissariat employs only a
small group of people, its work is aided by a number of planning commissions made up
of enterprise executives as well as representatives of labor unions and government. Some
of these commissions are “vertical” - they are organized on an industry basis (chemicals,
energy, mining, transportation, etc.) and concerned with a single sector exclusively. Other
commissions are “horizontal” and deal with issues common to the whole economy
(production equilibrium, financial equilibrium, manpower equilibrium, balanced regional
development, etc.)
Industrial policy, however, requires an adequate business system.
Business systems are distinctive configurations of firms and markets, which have
been established, in a particular environment as the dominant ways of structuring
economic activities.
Thus, industrial policy objectives can work out if only the big business concentrates
the prevailing economic power in decision-making and operation. This is achievable
either if the government is a major owner of big industrial enterprises (the French case),
or if the big business is highly concentrated and cooperates with the central government
owned resource allocation institution (the Japanese keiretsu system)
The guided market economy, indeed, is characterized as a dual economy: large
corporations and many small family-owned companies produce the largest share of GDP,
while the share of medium size businesses is insignificant and much smaller as compared
to the other models. The majority of small companies are subcontractors of big
corporations. They typically manufacture a subassembly or provide services sold only to
their major customer (a big corporation).
The matching capital markets mobilizing resources and providing the business with
the necessary funds is performed by the banking system. Banks play a substantial
corporate governance role in nonfinancial corporations. They are typically equity holders
in the real sector. A Japanese keiretsu is a business group organized around its “main
bank” which is the largest provider of debt financing and acts as a monitor in cases of
financial distress. Main banks appoint their employees to the boards of client firms and
participate in the corporate strategic decision making. Shares held by the banks and by
other entities in the keiretsu group are generally regarded as “stable shareholdings” and
display little variation over time. In particular, Japanese banks do not appear to adjust
their ownership levels in the client firms to changing economic performance.
This business system determines the emphasis on the long term goals. The heart of
the model seems to be the financial system that allocates capital not in order to achieve a
high short-run return on investment but to gain market share in strategic industries. Firms
are not constrained by the need to please impatient shareholders. For instance, 70 percent
of the stocks listed on the Tokyo Stock Exchange are owned by Japanese corporations
and are rarely traded. Access to “patient capital” takes pressure off managers and allows
them to concentrate on market share and long term resource allocation.
The stress on resource allocation means that social issues are not in the focus of
government care. Although it might be developing social programs, priority is given to
efficiency in allocation, not in distribution. Social matters are of interest of individual
workers, unions, or corporations. As a rule, social programs are created and developed as
an outcome of severe pressure on government.
The Modified Market Economy
The modified market economy justifies government intervention in economic
activity only in cases when markets fail to provide motivation for higher efficiency in the
private sector. The role and the size of public sector should be minimized.
Government intervention is determined by the social welfare function of the model
and has five main objectives:
1. to motivate private decision makers for efficient use of resources;
2. to trigger higher living standards;
3. to moderate inequality;
4. to contribute to social integration;
5. to guarantee efficient administration.
Welfare objectives are to guarantee higher efficiency of the market economy.
The first objective is guaranteed by developed and efficient capital markets. Thus, the
core institution of capital market is the stock exchange, ensuring capital flexibility based
on price signals and high liquidity of funds. Moreover, the model is characterized with a
broad variety of financial institutions and instruments motivating economic agents to
place every single penny into the most efficient use (according to the individual choice).
On the other hand, such a commitment assumes that short-term business variables
determine economic activity, as opposed to the guided market economy where long-term
perspectives and variables are of major concern. This is observed in the comparison of
the accounting standards, the satisfactory average rates of return to capital, and,
particularly, in corporate structure and management. While, for instance, the most
respected position in American corporations is the position of financial managers, in
Japan it is the one of the human resource manager who is concerned about stability and
cooperation within the firm. As to labor markets, they are the most flexible. As a rule,
firms easily open and close jobs and labor is extremely mobile. Efficiency in production
is, indeed, achieved by a workable competition. This is why, the modified market
economy cares most about the development and enforcement of antitrust legislation in
all cases when monopoly power hampers market contestability and competitiveness and
no exclusions are tolerated (As opposed to the social market economy, where unions
enjoy special treatment by the antitrust).
Higher living standards are associated with the idea of permanent consumption and
the fight against poverty. Since poor people have low purchasing power and cannot
stimulate the increase in production and production at full capacity, government should
prevent any decline in living standards and fight poverty. Thus, the welfare state
presumes a widespread system of consumer credit and a support of households whose
income is below the poverty line. However, the model relies on market based free choice
in resource allocation and it does not assume free education and healthcare. Social
programs are directed only to the poor, not to all citizens, as opposed to the social market
economy. Widespreading of social policies are believed to be a demotivating factor for
economic activity.
The aspiration for declining social inequality is justified by the requirements of the
free markets to provide firms with skilled and motivated labor. Since education and
training is basically a matter of individual choice, households should be wealthy enough
to afford decent living standards and higher level of education. Moreover, since social
tension (a factor decreasing efficiency and devotion to work) is a function of healthcare,
work and housing conditions and this is why problems along these lines should be
moderated.
Social integration is associated with the role of government to provide a sound basis
for high ambitions, positive motivation, and a full devotion to work. It is not surprising
then, that the U.S. economic system offers, more or less, equal opportunities to everyone
who is determined to make a career in the chosen field, when being gifted and working
hard. Moreover, work and honesty are, unquestionably, the most respected social values.
An evidence of the successful social integration is the diffusion of equity capital in the
U.S., though 1/3 of it is concentrated in institutional owners.
The efficient administration is expected to reduce the waste of time, energy, and
resources and to promote and sustain economic growth, innovation and workable
competition.
The Social Market Economy
Characteristics of the Social market economy.
The first principle of the social market economy remains that resource allocation
should follow the dictates of the market unless there is a serious conflict with national
social objectives. The state is responsible for ensuring the workability of competition.
This is the functional mechanism through which society will achieve highest economic
growth and prosperity.
However, the state plays a rather active role in limiting competition in four major
areas on the basis of its social responsibilities to the public: 1) the security of
employment, 2) the protection of employees, 3) insurance against the risk of workers, 4)
improvement in the distribution of income. Even though these instances are fairly typical
of most developed countries, the specific feature of the social market economy is their
comprehensiveness. Social equality and full employment are the first priority of the
social market economy. The progressive income taxes do not serve as the principle
vehicle for making the market determined distribution of income more equal. Rather, is
to use other instruments – the promotion of asset formation among lower income groups,
direct transfer payments (examples are child allowances and subsidization of rental
payments), and direct state intervention (government funding of social apartments).
The state supports programs to allow workers to share profits of their enterprises
as well as to have a say in the conduct of enterprise affairs (codetermination) – all of
which affect the real distribution of income. As opposed to the social and welfare
programs in the other models, here the policies are designed not only for the poor but for
everyone. This is why the government subsidizes heavily the prices of healthcare and
educational services.
One of the indicators for the identification of the social market economy is the
"rule of 40/20/35", meaning that government revenues should exceed 40 percent of GDP,
government expenditure should be at least 20 percent of GDP, and the Gini coefficient
should not exceed 0.35 percent.
The regulations of the labor market are a salient feature of the model.
Cooperatives (particularly in Sweden) and trade unions have a strong impact on policies
and corporate strategies and operation. In Germany, codetermination applies to almost all
industries. Codetermination means allowing worker representatives on the management
boards of industry, the objective being to force management to take workers’ interests
into consideration when making policy. On the other hand, employer associations are
very strong in the countries with a social market economy and are a powerful instrument
in industrial organization. They are members of the Chamber of Commerce and are
required to participate in the vocational education and training of the young, along with
the local governments and unions. Moreover, many students are able to acquire jobs at
the companies, involved in the vocational training. It is not surprising then, that the rate
of unemployment among the young is extremely low in these countries as compared to
the representatives of the other two models.
One type of state activity should be singled out – the extensive role played by
local governments in managing social and welfare programs, while the national
government is involved only in the national agreement on wages and basic legislation.
The participation of local governments and unions in business decision making
determines one important characteristic in corporate structure and management – the real
integration of the banking institutions with the industrial enterprises. Not only 70 percent
of savings are transformed into investment through the banking system, while the stock
exchange plays a modest role in capital allocation, but the major commercial banks are
major shareholders in industrial corporations and their members serve on the boards of
directors of these corporations. For instance, German companies have a much higher debt
to equity ratio than U.S. companies. This is a way to overcome the huge influence of
unions in corporate decision making. One more characteristic of the social market
economy should be outlined – the restrictive monetary policy of the central bank within
the context of the orthodox monetarism, in order to prevent high inflation rates provoked
by the social pressure.
Shortcomings and precautions.
The responsibilities of the social state for education, health care and the
unemployed correspond to the institutionalized traditions and the value system of Eastern
Europeans. However, the funds for such government support are collected through
enormous fiscal restrictions.
On the other hand, firms should increase their allowances for social funds and
accept a rise in salaries, faster than the increase in earnings at least by 1 percentage point,
which is a salient feature of the social market economy. The burden of social
responsibilities of the businesses raises the cost of production and worsens its
competitiveness. In the countries with a social market economy, the labor cost above
wages and salaries is higher than the OECD average by 6 to 8 per cent.
High tax rates create a basis for the underground economy, especially the part
associated with the avoidance of taxes. On the other hand, controlling underground
activities develops bureaucracy.
Participation of unions in decision making on all corporate levels establishes a
strong grounding for x-inefficiencies and allocative disproportions. In the countries with
social market economies time wasted for discussions and negotiations between the
Unions and the Businesses is higher than the OECD average by 2 - 3 percentage points.
The elevation of full employment as a priority of the economic system is
associated with high opportunity cost, price instability, and high interest rates. In the long
run, we witness serious monetary restrictions in all countries with social market
economies.
Another failure of the social market economy is associated with the priority of full
employment which may conserve backward industrial structures and worsen the country's
international competitiveness and deteriorating conditions of economic growth. The bitter
experience of the Scandinavian countries during the 1980s demonstrated the long term
consequences of such developments. The attempts for industrial and technological
restructuring undertaken by the conservative cabinets there just increased social tensions
and the rate of unemployment. Meanwhile, the institutions of the social market economy
were fairly mature and kept working, which created a paradox of sharply rising social
budget allowances under the conservative cabinet in Sweden.
Evidently, the choice of a model of market economy should carefully assess the
pros and cons of the social market economic institutions in the process of technological
and industrial restructuring. The slowdown of these developments might even intensify
social tension in the long run.