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German business
A machine running smoothly
Feb 3rd 2011 | BERLIN | from PRINT EDITION
THE silence is unsettling, as is the sight of half-assembled cars gliding about
on robotic transporters that move as if they had minds of their own. The scene
of this industrial serenity is Porsche s assembly line in Leipzig. The airy,
almost clinical factory provides a good illustration of how, even as its
European neighbours and other rich economies splutter fitfully out of
recession, Germany has been zooming along the economic autobahn.
The production line that ends in Leipzig spans whole countries. Painted bodies
for the Cayenne, a sport-utility vehicle, are brought by train from a factory
owned by Volkswagen (with which a merger is pending) in Slovakia. Those for the
Panamera, a hatchback, come in from Hanover. The robotic carriers then ferry
them from one group of assembly workers to the next. Parts arrive just as they
are needed. The system is flexible, allowing two different models to roll off
the line in exactly the required numbers. The cars then head east and west to
Porsche s two biggest markets, China and America.
The factory shows how Porsche has gained from globalisation and how Germany
has, too. On the demand side, the carmaker sells at premium prices to the world
s fastest-growing big economy and to simply its biggest. On the production
side, it uses expensive but flexible German labour on what can be seen and
cheaper east European workers on what cannot. Germany is by far the world s
biggest winner from globalisation, says Thomas Mayer, Deutsche Bank s chief
economist. It has benefited from both increased division of labour on the
production side and increased trade on the delivery side.
Related items
Germany s recent economic performance stands out among rich economies (see
article). Last year its GDP grew by 3.6%, the fastest rate since the country
was reunified in 1990. America managed 2.9%. Growth in the rest of the euro
zone probably fell short of 1%. Exports have been Germany s main engine: they
jumped by 21.7% in the year to November. In the first ten months of 2010 sales
to China were already 17% higher than in the whole of 2009 and 46% higher than
in 2007. No other big, rich economy has seen its exports to China grow so
quickly in the past decade (see chart 1). No wonder that business confidence,
according to a widely watched index produced by Ifo, a research institute at
the University of Munich, is at a record high, having recovered from a horrid
plunge in late 2008 (see chart 2).
The pace seems to be easing: The Economist s poll of forecasters suggests GDP
growth will slow to 2.6% this year, but that is still well ahead of the 1.5%
expected for the euro zone as a whole. The success of German business is plain.
It also raises a question: has Germany just been lucky to be making the sorts
of things that China and other fast-growing economies happen to need now, or
has it made its own good fortune? The answer is a bit of both, but there s
probably been more skill than luck.
Start with the improvement of Germany s biggest companies, which a decade or so
ago seemed to have been left behind by foreign rivals, even in sectors of
traditional German strength. Japan s Toyota was on its way to becoming the
world s biggest carmaker. America s General Electric (GE) was ensconced as the
world s largest industrial company.
Corporate Germany looked old-fashioned. Big companies were enmeshed in
cross-shareholdings with the country s leading banks that protected managers
from the grumbles of other shareholders and from takeovers. German reliance on
manufacturing looked like a weakness: the business of making things seemed
certain to migrate to Asia or eastern Europe, and Germany s service industries
were hidebound and over-regulated. Unemployment was chronically high and
unit-labour costs were above the euro-zone average.
These days corporate Germany looks rather different. Volkswagen, the country s
leading carmaker, wants to be the world s biggest by 2018. It is a realistic
ambition. The industrial bits of Siemens are now larger than GE s (ie, once GE
s media and financial businesses are stripped out). BASF, a chemicals
powerhouse, has managed to keep expanding at home and abroad, even as
production of basic chemicals has fallen in America and the rest of Europe.
The cross-shareholdings have been unwound: Deutsche Bank, for instance, no
longer owns chunks of insurers, carmakers or sugar processors. Big companies
are now concerned with serving their shareholders rather than workers and other
stakeholders (even if few boast about it: in Germany it would not be popular).
New chief executives have culled underperforming operations and focused on
growth, often abroad. Siemens, which used to be content to sell overengineered
and overpriced trains and generators to captive German buyers, has taken a leaf
from GE s book, selling businesses where it lacked scale, for instance in
consumer electronics, and concentrating instead on areas in which it has a
chance of being among the world s leaders, such as energy and medical
technology. Once its primary concern seemed to be to preserve jobs in Germany.
Now two-thirds of its employees are abroad. Linde has gone from being a
diverse, second-rate engineering firm to become Europe s, and one of the world
s, leading producers of industrial gases.
In the engine room
The main motor of Germany s growth, however, is the Mittelstand, a legion of
mainly small and medium-sized firms, typically family-owned and highly
specialised, that build products that dominate obscure branches of industry. If
a particular job can best be done by a machine, then the chances are that the
machine in question was built in a small town in Germany. Wirtgen is a leader
in making machines that recycle tar and grit from old roads to be relaid as
smooth new ones, as is Leitz in making wood-processing tools. Machines that
make other things are a Mittelstand speciality. Kugler-Womako, a champion in
production lines for printing passports and Winkler+D nnebier, which makes
machines that produce envelopes, are just two of the firms that Hermann Simon,
a German management consultant, identifies as the country s hidden champions .
In some respects the Mittelstand is a philosophical construct, rather than just
a description of company size. Firms such as B. Braun, a family-owned maker of
medical supplies, or Bosch, an engineering group owned by a charitable
foundation, are a good deal larger than many listed firms, yet still espouse
what they would claim are Mittelstand values: attention to detail, financial
caution and co-operation between bosses and employees. Bosch, for instance,
tightened its belt in the downturn without mass lay-offs. Last year its sales
were a record 47.3 billion ($62.6 billion), up by 24% from 2009, and it
returned to profit. It plans to increase its labour force from 283,500 to about
300,000 this year. Most of the new staff will be abroad, especially in Asia.
Firms of all sizes have spread themselves abroad, in search not only of markets
but also of cheaper production. Germany is not just a leading exporter; plenty
of imports arrive in towns all over the country to be assembled into costlier
goods and sent abroad again. Michael H ther, the director of the Cologne
Institute for Economic Research, reckons that the import content of German
exports has gone up by about ten percentage points to more than 20% in the past
decade.
German firms have also been adept at outsourcing. In 2004 a study by McKinsey,
a firm of consultants, concluded that the economy gained just 0.80 (then about
$1) for every 1 of corporate spending that German firms sent offshore. At the
time America gained more than $1 for each $1 of spending its companies moved
abroad. Not only were German firms less good at finding productive
opportunities in foreign countries; German workers, if displaced, were less
likely to find new jobs quickly. The gap seems to have narrowed, as companies
have reaped the benefits of moving production, and some services, to cheaper
places, while jobs have been created in Germany too. Recent studies suggest
that German firms have cut labour costs by as much as 70% by shifting
production of some components abroad.
In this Germany has been blessed by geography, as some of its main
manufacturing regions abut formerly communist states with cheaper but still
well-educated workforces. This has allowed Porsche, Volkswagen and others to
move production to the east far more easily than, say, British firms have been
able to do.
Forced to be flexible
Cheap labour on the doorstep has also helped to hold down costs at home. The
ease with which jobs can be shifted has given German employers extra power in
pay negotiations. This goes a long way to explaining why real wages in Germany
have remained essentially flat in the past decade while they have climbed in
most other countries that use the euro. Employers and unions have also made
agreements to establish flexible working hours: workers put in extra shifts at
busy times and have time off when things are slack. We had to learn to breathe
with the cycle, says Ralph Wiechers, the chief economist of the VDMA, an
industry group.
German industry s steely ability to hold down costs was also helped by the
Hartz reforms, introduced when Gerhard Schr der, a Social Democrat, was
chancellor between 1998 and 2005. Many in business credit the economy s rebound
to these reforms, which freed up labour markets and made work more attractive
than life on unemployment benefits.
For workers, who conceded flexibility and agreed to wage restraint, the bargain
has meant they have kept their jobs, even during the depths of the downturn
when most German firms cut working hours instead of firing people. This was
especially true in the Mittelstand. Engineering firms, which saw orders
collapse by almost a quarter during the recession, cut employment by about 8%.
About 10% of smaller firms had to reject orders because they could not get
credit, says Mario Ohoven, president of the German Association of Small and
Medium-sized Businesses. Only a small fraction of these shed workers.
The costs, and risks, of keeping people on the payroll were partly shouldered
by the state. Nevertheless, they represented a belief that demand for German
products would rebound quickly. It did, and firms were in a strong position to
speed up production. Now that German unemployment is shrinking again at 7.4%,
seasonally adjusted, the rate is at its lowest since 1992 many firms are
fretting about a shortage of skilled employees.
But costs are only part of the equation. Bain, a management-consulting firm,
reckons that German companies have come out of the West s economic crisis
nimbler than ever. Many would have planned capital spending once a year, for
instance. Now they do so every few months. The latest recession went so deep
that it finally unlocked some real change, says Oliver Str hle, a partner at
Bain.
Precision pays
As important has been the bloodhound-like ability of Germany s firms to sniff
out niches where competition is the least fierce. From the Mittelstand up,
German firms have found a blend of engineering, technology and service that has
allowed them to increase their share of world markets. They have done this by
excelling in areas that demand constant, incremental innovation. The purchase
price of a specialised machine may be less important than its reliability and
the support and services that are sold with it.
The state has helped with research support as well as with the Hartz reforms,
doling out cash in support of industries that it thinks are important areas of
growth such as green energy, security or biotechnology. It supports an
extensive research infrastructure that small and medium-sized firms can tap
into when they need help, lowering the barriers to innovation. The Fraunhofer
research centres spend about 1.6 billion a year and employ more than 18,000
people. Most of their work (and about two-thirds of their funding) is related
to helping firms with specific projects.
Green machine
The government has tried to create winners as well as support them. Germany s
growing green-energy industries are largely creations of the state. Generous
subsidies have made the country the world s biggest market for solar-power
installations. It may have sucked up half of global production in 2010. Almost
a quarter of patents awarded in 2007 for renewable-energy technologies went to
German firms.
The results of this have been mixed. On the German bank of the river Oder stand
factories that the government had hoped would be world-beaters in making
photovoltaic cells. But they have been undercut by Asian competitors which now
supply most of the gleaming modules sprouting in Bavarian fields. Germans have,
though, become top dogs at making the machines that make the cells: Manz
Automation is one of the biggest producers of equipment used to make thin-film
solar cells. Three-quarters of its machines are sold to Asia.
Germany s success in emerging markets is a source of both pride and
vulnerability, for it would be hard hit were growth there to slow. The extent
to which exports to a single market China have flattered the income statements
of German firms is worrying. Growth in many of Germany s other markets, in the
euro area and beyond, is already sluggish. This year looks as if it will be
harder than last.
Moreover, Germany still has hard work ahead of it. The services sector, despite
some liberalisation (for instance, in retailing) is still underdeveloped. A
system of schooling that has proved reliable in turning out industrial workers
needs an overhaul (see article). For all of the success of German firms in
exporting goods, some German banks made the mistake of buying American mortgage
debts. The banking system, especially the publicly owned bit, is yet to recover
fully.
None of these problems is insurmountable and Germany, unlike many countries,
has the time and budget to deal with them. The risk, however, is that Germany
may choose to bask in its triumph and to slip back into old habits, suppressing
domestic demand and focusing all its efforts on exporting more. We are living
a bit on borrowed time in a sweet spot where the deficit countries haven t yet
adjusted, says Deutsche Bank s Mr Mayer. One of the big risks is complacency.