In German economic policy, there are a number of complex structures that serve to make the economy as stable and crisis-proof as possible in the long term. In this context, the Magic Hexagon defines certain goals to be achieved by economic policy. The government’s economic measures are based on this foundation.
Magic Hexagon: The History of its Origin
An origin finds a magic hexagon in the Stability Law, which is valid since 1967. The law came into being against the backdrop of the first economic downturn in Germany after the Second World War. Up to this point, the government under Chancellor Dr. Ludwig Erhard government intervention in the economy largely rejected. However, an increasingly tense federal budget situation eventually led to Ludwig Erhard’s resignation. The new Chancellor, Kurt Georg Kiesinger, together with his Federal Minister of Economics, Dr. Karl Schiller to bring about a turnaround in economic policy. A series of economic stimulus programs and the Stability Act were intended to put an end to the economic crisis and state leadership that had persisted for several years.
To this end, the Stability Law was guided by various objectives, which are referred to as the Magic Hexagon.
These goals were:
- Price stability
- Full employment
- external economic balance
- Appropriate economic growth
The Stability Act was intended to open up the possibility for budgetary policy to take measures to influence the state of the economy, depending on the state of the economy.
Influenced by Keynesianism
If you want to understand the basic idea behind this economic policy of the Federal Republic, it is necessary to understand the Theory of Keynesianism to understand. The Briton John Maynard Keynes is considered one of the most important economists of the 20th century. The Stability Act was a nineteenth-century economic policy strategy and held the view that the market does not automatically ensure full employment if it is left to self-regulation. In his opinion, it is therefore the task of the state, to even out fluctuations through intervention. This is the only way to ensure a stable economy. His doctrine therefore states that the state must be supported by Countercyclical measures must smooth out cyclical fluctuations so that a stable economy can emerge.
Gesidential demand in Keynesianism
In order to achieve economic stability, Keynesianism considers the overall economic demand as the most important. Countercyclical behavior by the government is necessary to maintain this demand in times of crisis. This behavior is the best way to ensure that the goals of the magic quadrilateral are achieved in the long term. This principle continues to apply in German economic policy today.
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Extension to a magic hexagon
In the years following the creation of the Stability Act and the magic quadrilateral, societal changes occurred that produced additional values that expanded the quadrilateral into a magic hexagon. In addition, the points "fair distribution of income and wealth" and "preservation of an environment worth living in" have been included. Since 1997, the protection of the environment has also been part of the Basic Law, and in a time of climate change and increasing concern about its effects, it is gaining ever greater importance. If the goals of the Magic Quadrilateral were quantitative goals, the two points that make the quadrilateral a hexagon represent qualitative goals.
Magic Hexagon: Understanding the individual goals
In order to understand the goals of economic policy and their interrelationships, it is necessary that you first analyze the individual Magic Hexagon goals. In this way you can gain knowledge about how and why certain decisions are made in politics. Federal government decisions can often have profound consequences for the population. If you understand the Magic Hexagon principle and its mechanisms of action, you can often protect yourself against unpleasant surprises. A knowledge of the Magic Hexagon can help you, for example as a private investor, to predict certain decisions and their impact on your investments.
Goal 1: Full employment or the highest possible level of employment
One of the goals of the magic hexagon is to create a the highest possible employment rate or full employment to achieve. This target will be z.B. at which Unemployment Rate measured. This is considered one of the indicators of the Magic Hexagon. The unemployment rate in Germany is calculated according to the following formula:
number of registered unemployed x 100 / (number of all civilian employed + unemployed who are not registered).
In economics, one speaks of full employment when an unemployment rate of less than 3% prevails. This is based on the fact that even in a perfect economic situation, a certain degree of unemployment cannot be avoided. A good example is construction workers who cannot work on construction sites during the winter period due to weather conditions. A certain percentage in the unemployment rate is also that there are always people in the population who prefer not to work, although they would be able to do so.
Part of the unemployment rate is also always caused by so-called frictional unemployment. This refers to those people who have lost or quit a job and are looking for a new job. This unemployment is usually only short term.
A low unemployment rate is a desirable goal for the state for economic reasons. Less money is spent on supporting the unemployed, while collected contributions for concepts such as taxes and social security contributions increase.
In order to meet the goal of maximizing employment, the state has a variety of measures at its disposal to. These include:
- Plans for a long-term structural policy
- Constantly open up new markets
- Granting wage subsidies.
- Create optimization with government subsidies.
Goal 2: Price stability
This objective also marks an important point within the Magic Hexagon. One speaks of a functioning market economy when the Price level stable is. On the one hand, this stability makes social peace possible and, on the other hand, creates the basis for acquisitions and investments. Geopolitics ensures the stable price level. This can be restrictive if necessary. One instrument for this is the key interest rate. By raising or lowering the Key interest rate the general monetary policy and the development of interest rates are influenced. Raising the key interest rate is considered a restrictive monetary policy. It becomes more expensive for banks to borrow money from central banks. Accordingly, high interest rates are also passed on to bank customers. For them, this results in a scenario where credit becomes expensive and unattractive, but savings become more lucrative.
Expensive financing contributes to entrepreneurs investing less. Private individuals are also borrowing less to build houses or buy consumer goods.
The price can no longer rise and demand falls
Demand falls, which means that suppliers can no longer easily raise prices. If, on the other hand, the prime rate is lowered, credit becomes cheaper, which boosts the economy. Low interest rates make investments cheaper for companies and lead to a revival of the economy. As a consumer, it becomes less interesting for you to save because you receive little return on your savings. On the other hand, you can borrow cheaply and finance larger projects such as buying a house more easily. Consumption increases.
In most cases, a lowering of the key interest rate also goes hand in hand with a Devaluation of the currency Hand in hand. As a result, domestic products can be offered more cheaply abroad and sold better. As a result, export figures increase.
An inflation rate of 2% would be ideal
The European Central Bank now believes that an inflation rate of two percent is ideal to keep prices stable. If inflation rises rapidly above this level, so that goods are threatened with a loss of value, inflation is limited by increasing the key interest rate. On the other hand, if the inflation rate falls substantially below two percent and the economy stagnates, this can be stimulated by lowering the key interest rate.
Another means that can contribute to maintaining price levels are moderate wage settlements, which are negotiated in the case of tariff agreements.
Goal 3: External balance
Few people realize what extra-economic equilibrium actually means. Therefore, you should first learn the definition for this term. External equilibrium means a Balancing the current account and net exports. Thus, equilibrium is achieved whenever the money received from abroad is equal to the amount channeled as payments abroad. Put simply, the country’s imports should be equal to its exports.
In order to understand the importance of foreign trade equilibrium, you should get to know the goals that are realized through foreign trade.
Comparative advantage
The comparative advantage is the main incentive for foreign trade. It always arises when different countries have different possibilities for the production of certain goods. If, for example, better cars are built in Germany than in England, but better woolen sweaters are made in England, it makes sense to exchange cars for woolen sweaters. Thus the international trade begins.
Size and learning effects
Global trade leads to economies of scale and learning effects. The economy of scale results from the simple fact that foreign trade leads to new markets for the firm. This allows companies to increase their production capacity and possibly offer a lower unit price in this way.
However, foreign trade can also create learning effects. Through the exchange with other countries, there is automatically also an exchange of knowledge, which can extend over different industries. In many cases this knowledge leads to a reduction in production costs.
Reduction of market power
Foreign trade can also help to limit or reduce the market power of individual companies. If trade takes place not only at home but also abroad, competition intensifies. You are no longer competing exclusively with companies in your own country, but also with companies abroad.
How to measure external balance?
If you want to measure whether there is an external equilibrium, you only have to compare the ratio of imports and exports with the corresponding current account balances. However, exchange rates can also provide information about the external balance of the economy. You have to distinguish between the nominal and the real exchange rate. The nominal exchange rate sets the value ratio of two currencies. A distinction is made between quantity quotation and price quotation.
With the nominal exchange rate you can find out how many units of a foreign currency are available for one unit of domestic currency. With a rising exchange rate, you receive a higher amount of foreign currency for one unit of domestic currency. External equilibrium exists when the exchange rate remains stable in quantity quotations.
The real exchange rate is the nominal exchange rate adjusted by the price level of both countries.
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Goal 4: Appropriate economic growth
If a country is to be stable in the long term, consistent economic growth is a basic prerequisite for this purpose. A growing economy guarantees that citizens will find jobs can. This in turn enables them to buy goods and pay taxes. This creates a cycle that forms the basis of trade. However, the goal within the Magic Hexagon is not merely economic growth, but economic growth that is commensurate with. This brings up the question of what is meant by adequate.
Experts believe that an annual increase in the Gross Domestic Product (GDP) of 5% best represents this appropriate value. It should be noted that this figure is not to be taken as a statement of actual prosperity. Several unknowns, including undeclared work, distort the picture.
Why economic growth must be appropriate?
The economic growth must be in the correct proportion to avoid crisis situations. An economy that grows too fast can destabilize price levels and also lead to declining employment. The external economic balance is then also threatened. Therefore, an economic boom can very quickly turn into an economic crisis. If, on the other hand, the growth is too low, this will also have negative consequences for the economy. This is why the government tries to keep economic growth at a controlled level. Through various actions, the state controls economic growth that is too fast as well as too slow. This includes, among other incentives, the raising or lowering of the exchange rate Taxes.
Goal 5: Magic Hexagon Maintaining a livable environment
Preserving a livable environment is a goal that the federal government has increasingly pursued since the 1990s of the last century. Governments today have recognized the devastating impact human trade has on the environment. At the same time, the awareness sets in that continuation of the human race on our planet can only be guaranteed if the environment is protected. However, this qualitative target of the Magic Hexagon possibly around the point that raises the most conflicts. Indeed, the economy makes use of many natural resources, which environmental protection must restrict.
Reorientation to modern technology
This means a slowdown in numerous sectors of the economy. However, this also creates the opportunity for reorientation and the development of modern, resource-saving technologies. However, such measures mean upheaval and thus also uncertainty. Two examples illustrate this trend. Today, the automotive industry is faced with the task of developing electric cars, which will have to replace fuel-powered vehicles in the long term. The lignite sector is similarly affected. The cessation of lignite mining means a major loss of jobs. An alternative to the provision of new jobs in this sector has yet to be found. A Structural change must be organized and financed.
Magic hexagon Environmental protection metrics
The successes with regard to the achievement of goals in the field of environmental protection are based on the values of the ecological balances. Their rules and principles are internationally defined by the IOS standards, which have also become part of the German DIN norm system. The LCA is characterized by the following four elements:
- Definition of the scope and target
- Factual Balance Sheet
- Assessment of the impact
- Evaluation
Besides a general ecological balance, in which all factors are taken into account, there are also specific balances. These include, for example, the CO2 footprint and the water footprint. These can provide an accurate insight into the greenhouse effect and the water balance, respectively.
Goal 6: Magic hexagon Equitable distribution of income and wealth
A fair distribution of income and wealth that is accepted by all citizens is difficult to achieve in our free market system. Neither income nor wealth can be formed freely; rather, they are dependent on the principle of supply and demand. The per capita wage ratio is considered an indicator of this objective. There are some mechanisms through which the state could promote the achievement of the objective. This can be achieved, for example, by adjusting taxes. However, government control in this sense is made more difficult by the fact that possible measures are in direct conflict with other goals. This does not make the fair distribution of income and wealth fundamentally impossible. However, the consequence of this is that it directly affects other goals.
Magic hexagon: goals and their measurands
Section 2 of the Stability Law requires the federal government to publish an annual economic report every January. This shows, among other things, how the economy has developed in relation to achieving the goals from the Magic Hexagon. Each of the six goals is assigned metrics that allow comparison with the previous year’s values. These take the following form:
Conflicts and harmonies in achieving goals in the Magic Hexagon
A Magic Hexagon is a figure in which many measures are possible that can lead to the achievement of one of the included goals. However, the use of many of these measures creates a negative effect on other goals. For example, external balance is achieved through the imposition of protective tariffs or import restrictions achieved. However, such measures have a negative impact on economic growth, which is also one of the objectives in the magic hexagon. Full employment may also be threatened by such a measure.
A high export rate brings on a strong Upward pressure on value with itself. If non-European countries want to buy many German products, there is an increased demand for the euro. However, if one tries to equalize imports and exports, economic growth is likely to slow down as companies lose parts of their market.
Target relationships Magic hexagon: Further examples
The target relationships in the Magic Hexagon can be Harmony of goals or conflict of goals and if the goals are in harmony, the goals can be achieved together. In a conflict of goals, on the other hand, one goal interferes with the other. If one moves along a line in a harmony of goals, one approaches two goals at the same time. If there is a conflict of goals, each step towards one goal moves the company further away from the other goal.
Full employment and stability of the price level: A conflict of goals
Full employment and a stable price level can be two goals that conflict with each other. Once full employment is reached, this situation grants unions a position of power in negotiating collective agreements. Therefore, they are able to negotiate higher wages for workers. However, higher wages lead to the fact that the Production costs of the companies increase. These increased costs are now passed on to customers through increased prices. At the same time, wage increases give workers greater purchasing power and increase demand for goods. An increase in demand also causes prices to rise. Thus, if a state is in a state of underemployment and begins to take measures that lead to full employment, the Magic Hexagon price stability may falter. Both goals are in conflict and cannot be achieved at the same time.
Magic hexagon: conflicting goals of full employment and external balance
A state can Export surplus achieve if it exports more goods to foreign countries than it imports goods from abroad. In such a case, the state can take measures to reduce the export surplus. This can include export tariffs, an increase in the currency or agreements with other countries. These measures then result in companies finding less demand for their products on foreign markets. This leads to a limitation of production. For lower production, fewer workers are needed and companies lay off workers to adjust their operating costs to the current situation. Higher unemployment results and the state moves away from achieving the goal of full employment, while moving closer to the goal of external equilibrium. There is therefore a magic hexagon conflict of objectives.
However, it is also possible that there is a harmony of goals between full employment and external equilibrium. This is the case when a state experiences a Import surplus exists. In other words, more goods are imported than exported. Thus, in order to achieve external equilibrium, the state takes measures that make imports less attractive while creating a climate that favors exports. As a consequence, demand for goods from within the country increases. To meet demand, firms must increase capacity. To do this, more workers are hired. While an external equilibrium is achieved, full employment is also approached at the same time. There is a harmony of goals in this case.
Magic hexagon: target relationship between external equilibrium and price level stability
Achieving external equilibrium can be in harmony with the goal of price level stability, but it can also be in conflict with that goal. If the external balance is achieved by reducing the export surplus, the number of employees decreases with it. From a previous example, it was already apparent that price stability and full employment are in conflict with each other. Thus, if the balancing of the external economy leads away from full employment, price stability will be achieved at the same time.
If, however, in the opposite case an import surplus must be balanced in order to achieve external equilibrium, the state simultaneously approaches full employment, which triggers an increase in prices. In this case, then, a conflict of goals arises.
Full employment and adequate growth: Magic hexagon Conflicts and harmonies
To achieve appropriate growth to be able to achieve are Investment Necessary. If investments are to be made, however, a certain amount of saving is also necessary in order to be able to finance them. In order to be able to save, one limits the Consumption. There is a diminished demand. As a result, employment is also reduced. A lower employment rate leads to price stability. Thus, there is a harmony of objectives between adequate growth and price stability, but there is a conflict of objectives with full employment.
If full employment exists, it is possible to save a lot of money. High saving favors investment, which is necessary for adequate growth. Full employment makes capital formation and appropriate growth easier, so there is a harmony of goals.