Germany's export industry in a US-China squeeze

Germany’s economic success is under threat. Berlin needs to reduce the country’s dependency on exports by stimulating domestic growth―and push for robust European trade and industrial policies.

The German export-oriented economic model is under attack this year: Germany is caught between tough American protectionism and aggressive Chinese industrial policy. The US government is threatening to impose painful sanctions on key German export goods, such as automobiles, while China’s industrial policy is focused on acquiring important industrial technologies, and eventually replacing existing foreign technology leaders in the automotive, engineering, and chemical industries.

Because of the sizes of their markets, the United States and China unquestionably have the tools to hurt Germany’s export-oriented economy. The new German government under Angela Merkel will have to counter the effects of the US-Chinese squeeze.

First, German dependence on exports to the United States and China must be reduced. The focus should be on strengthening growth forces – and not just in Germany, but Europe as well. All euro area countries except France, Finland, Cyprus, and Belgium have current account surpluses, and Germany’s surplus amounts to almost 8 percent of its GDP. The euro area as a whole has a surplus of around 3 percent of GDP. These external surpluses are no longer sustainable in a world in which the US president is threatening to launch a trade war and the World Trade Organization can no longer regulate open markets in key economies.

Germany’s capital investment is lagging behind. Even without this acute pressure, it would be in Germany’s interests to set domestic growth forces free. German business investment has been weakening for years. German gross investment in the industrial sector has been lower even than in France or Italy since the start of the millennium. A timely and feasible step would be to massively improve the rules for depreciating assets on capital, software, and research investments in the German tax code. This is all the more necessary now as US corporate tax reform will allow companies to immediately depreciate 100 percent of their expense for equipment and building upgrades.

Beyond reforming the tax code and lowering other regulatory barriers, Germany will have to accelerate the development of public infrastructure. Improvements are urgently needed for the country’s roads and public transport infrastructure, as well as its data infrastructure and broadband network. Schools and universities could use more funding as well. The increased availability of both private and public capital will also help raise wage levels in Germany. After all, capital complements most labor activity. This set of measures would promote domestic growth and reduce dependence on exports; the resulting growth in Germany would also help its EU partner countries by increasing demand for their products.

Promoting Infant Industries

Second, German innovation policy must also make a real leap forward, especially in the digital economy, so as not to leave the future of technological change entirely to others. American and Chinese IT corporations are in the process of dividing up world markets, setting technological standards that will be associated with huge licensing revenues in the future. They are also making significant advances towards the technology of the (near) future: artificial intelligence.

At the moment, neither Germany nor Europe has a lot to offer in terms of a digital economy. The EU’s Digital Single Market is not progressing. As early as 2019, Europeans will become painfully aware of the shortcomings in their networks’ innovation policies when the Chinese company Huawei begins to install 5G mobile technologies in Europe, a prerequisite for networked industrial production and autonomous driving.

Europe needs a much more ambitious and active digital innovation policy, one that includes the targeted promotion of European “infant industries,” for example through the development of larger venture capital markets. Research shows that scaling companies is more difficult in Europe than in the US due to lower access to venture capital in all industries. With regards to critical infrastructures, there should be no taboo on the targeted support of currently weak European 5G developers, such as Nokia or Ericsson. If European semiconductor and mobile network companies disappeared from the markets, after all, dependencies on US and Chinese technology providers would not only create security risks, but would permanently reduce European innovation capacities.

European governments will therefore need to fundamentally rethink their innovation policies, and in particular their digital policies, in order to counter the rush of American and Chinese companies and innovations. The German coalition agreement does hint at the importance of research, but it gives the impression that rather marginal changes are being considered, when a qualitative change is needed. Company- and market-driven “innovation from below” will be necessary but insufficient; digital transformation requires new, state-financed infrastructures, targeted support measures, and educational offers as well as continuously adapted market rules provided by governments and parliaments. Public innovation policy must simply become more ambitious and think in terms of bigger goals and dimensions. Substantially strengthening research and development spending in the European and German budgets is only a first necessary step in this direction.

Screening Foreign Investments

Third, Germany should campaign for a robust foreign trade policy in Europe. On the one hand, this is about adequately examining security interests in foreign investments and acquisitions and flanking them with a pan-European coordination office. On the other hand, it is also about protecting strategic technologies from being taken over through market manipulation practices. For this task, the competencies of the EU Directorate-General for Competition should be strengthened. It is completely unacceptable that foreign top dogs operating with state funding from closed domestic markets should be able to drive European companies out of the European market.

Germany must stand up for open markets and fair trade practices more decisively than before through the EU’s Directorate-General for Trade, without weakening the European institutions through unilateral action. European Trade Commissioner Cecilia Malmström is doing a very good job, not only in her negotiations with the United States and China, but also in establishing new strategic trade relations with, for example, the Latin American Mercosur, along with a free trade agreement with Japan. Europe should build further partnerships and, at the same time, sharpen its trade policy instruments to defend itself in the case of conflict and represent European interests more effectively than before.

Germany can no longer avoid an economic policy correction in the face of the dual pressure coming from the United States and China. The new German government has to act now if it wants to defend domestic industries from unfair competition while releasing Europe’s own growth forces.

​​​​​​Guntram B. Wolff  is Director of Bruegel, the Brussels-based European think tank specializing in economics.

This article was first published by the Berlin Policy Journal on April 26, 2018 and was simultaneously published by MERICS and Bruegel on April 30, 2018.