The idea underlying the social market economy is that the free market efficiently produces a quantity of goods and would distribute them in a certain pattern among the economic agents who produced it, but that this distribution can be made morally and practically better by making it more “social". This can be done by interventions that do not react back on the productive functions of the market, leaving it free and untroubled. In addition, the economy yields a bonus, so that total production is not only (morally) better distributed, but also greater than it would otherwise be; for in the social market economy, relations between employers and employees are more peaceful, less antagonistic and hence more productive than in a mere market economy.
Let us deal with the minor issue, the bonus first. History provides only meagre lessons about why social upheavals happen and how they are prevented, but such lessons as it does give tell us that revolutions happen after oppression is relaxed and social order is disrupted more by the appeasement of tensions than by the tensions themselves. Concessions to the weaker party teach it that it is entitled to concessions, and will demand more. Industrial relations tend to be worse and strikes more prevalent under heavily redistributive left-wing governments. There is not the slightest evidence that the rise of the welfare state was conducive to industrial peace and productivity, let alone that it “saved Europe for capitalism" after World War II. [Cont'd - click 'read more']
The major thesis of the social market fallacy is that production and distribution are somehow distinct from one another. The purest form of this gross error is the slicing-the-cake simile to which it is often reduced in its popular versions. The social product is the cake, it is all ready, baked and now it is up to some social consensus to decide how to slice it, how big a part to give to labour, to capital, to management etc. Indeed, it sounds plausible that the cake is baked first, distributed afterwards. J.S. Mill was the first to plant this fallacy in the popular mind. For in fact production and distribution happen simultaneously and are interdependent. Who gets what part of the cake is decided while it is being produced (and partly before it). The reason why each factor of production takes a part in baking it is that by contract or tacit custom it is promised to get a certain slice of it. It is this promise that is being broken when the government, inspired by the naïve idea of the “social market", overrides the distribution that had induced the cake to be baked by a redistribution once it has been baked. But this cake cannot possibly be the same as the one that would have been produced if the promise of free market contracts and thus market-determined wages and profits, had been and could have been expected to be kept.
As a last-ditch defence of the “social market", its more sophisticated advocates might admit that the cake called into being by redistribution may well be a bit smaller or taste less well than the one that would have been produced in response to the natural distribution. But this probable shortfall, they argue, is the price we pay for making the distribution, more equal, hence morally superior. The moral superiority of a more equal distribution is an affirmation that is perfectly arbitrary, a bluff waiting to be called. It draws its force from the confidence with which it is announced. An attempt to derive it from something deeper and less subjective than itself is the recourse to arguments of social justice.
Extracts from a speech introducing Liberale Vernunft, Soziale Verwirrung, 27 January 2009 in Zurich.