Lisbon 2 Vladivostok

_ Yuri Kofner, junior economist, MIWI – Institute for Market Integration and Economic Policy. Munich, 3 December 2020.

Industry (manufacturing) is of the utmost importance for the German economy in terms of macroeconomic value creation, productivity, innovation, and as an employer. The success of the German industry is based on the model of the social market economy.

The traditional success model of the social market economy is based on horizontal industrial policy (industrial Ordnungspolitik), whereby a vertical, selective industrial policy may be used only in exceptional cases in order to respond appropriately to a disruptive structural change (e.g. the integration of East German industry as part of German reunification in the 1990s). Under the pretext of counteracting climate change and the Corona crisis, the policymakers in Berlin and Brussels are increasingly deviating from this model of success.

Germany must return to the model of horizontal industrial policy, which is based on four basic principles: (1) Identifying market opportunities is the task of competing companies; (2) the state must create a transparent, business-friendly, and reliable regulatory framework; (3) state interference in market activities must, apart from a few clearly defined and justified cases, remain an exception; and, (4) social prosperity and high social standards can only be ensured through strong international competitiveness of domestic companies.

In the medium term, Germany as an industrial location is facing the following major interrelated challenges: falling productivity growth and the zombification of the corporate landscape; digitization and rising market power of digital platform economies; stringent climate-mitigation requirements and high electricity prices; increasing protectionism in world trade and competition with China; demographic change: population aging and mass immigration of low skilled labor; as well as a relatively high tax level in Germany. Relatively high cost pressure as a comprehensive result of these factors is one of the greatest obstacles for further production localization in Germany.

In the following, the most important reasons for these challenges are given, as well as suitable evidence-based industrial policy responses from the MIWI Institute:

The declining productivity growth and the zombification of the economy are mainly due to: the expansionary monetary policy of the ECB (borrowing has become easier); an aging population (“savings glut” – decreasing propensity to invest in Germany); declining start-up dynamics; and growing state (especially “climate” and Corona-related) subsidies.

In this context, the German government should: push towards a reform of the monetary policy in the euro area (either a return to a restrictive monetary policy, or the exit from the euro, or the division of the monetary union into a “north” and a “south” euro); make a private domestic investment in (venture) capital more attractive (through tax incentives, the creation of scale-up funds, the creation of a European market for venture capital); remove bureaucratic barriers to business start-ups; and reduce government subsidies (where possible).

Digitization (Industry 4.0) is a dynamic, disruptive structural change, which affects the German economy in three areas: insufficient growth of the necessary technical infrastructure; a lack of digital know-how by the labor force and the companies; rising market power of American internet companies accompanied by insufficient regulation of digital platform markets.

In these three areas the government should: primarily stimulate market-oriented self-financed network expansion, but also make state investments in the technical infrastructure more efficient (simplification of the acquisition of new cell phone sites, acceleration of the approval process, gigabit vouchers, digitization, and gigabit connection of authorities); support the provision of educational services in the field of IT and AI at universities and in dual vocational training; simplify digital funding for businesses (reduce application bureaucracy); stimulate the creation of cross-company data pools; implement a comprehensive improvement of the German federal AI ​​strategy; create of a transparent, clear and reliable competition regulation of the digital platform markets (including transparency of the algorithm effects, reducing market entry barriers, fair taxation).

German companies traditionally follow the “second mover” model. Accordingly, in the digital economy, it may not be advisable to try to outperform American digital corporations with protectionist and state aid measures. Instead, potencies for niche markets and application services could be supported. The creation of the EU digital single market is to be welcomed because of the economies of scale.

In contrast to digitization, the declared goal of CO2 neutrality is neither of technological nor of market-based origin, but purely political in nature. However, the climate requirements and carbon taxes of the federal government and the EU (e.g. the Euro 7 emissions standard, climate-neutral building regulations, etc.) have a sensitive negative effect on the competitiveness of the German industry, especially on the domestic automotive industry.

A completely alternative approach could be one of two possible strategies. Based on the hypothesis that the anthropogenic factor has no decisive influence on climate change, the federal government could oppose state-driven attempts to slow down or even prevent climate change. Instead, the industrial policy could use R&D funding to focus on the socio-economic adaptation or even on harnessing potential benefits of global warming (e.g. increased farming yields in northern regions, opening up of the Northern Maritime Route, etc.). A subordinate realpolitical compromise approach would be to support climate mitigation policy, but to consistently insist on market-based price signals, i.e. the abolition of all unilateral bureaucratic and financial climate regulations and instead of striving towards an international emissions trading system “on everything”.

As a result of the politically desired energy turnaround (Energiewende), Germany as a production location is also suffering from among the world’s highest industrial electricity prices. Half of these high costs are caused by taxation (for example, the EEG surcharge, the fuel taxes, etc.).

In order to ensure the competitiveness of the manufacturing industry and of the digital economy, domestic electricity prices must be reduced significantly by: reducing the tax component, securing the import supply of natural gas, expanding the domestic and European electricity grid, and, most importantly, by returning to nuclear energy. Overall, the power generation system needs to be freed from government redistribution measures and needs to be based, once again, on market-economy principles and technology-openness.

In addition, the German competitiveness is losing in a European and international country comparison, primarily due to one of the world’s highest tax levels, especially in corporate taxation.

In response to this, the tax burden on companies must be significantly reduced, including: the complete abolition of the solidarity surcharge, the lowering of the capital gains tax on venture capital for SMEs, the lowering of the corporation tax by 5 percentage points, the reform of income tax rates (the straightening of tax rates). To compensate for the forgone government revenue, the level of state aid, which has increased significantly over the years, needs to be reduced again.

The shrinking and aging German population is one of the biggest challenges for the traditional system of the social market economy in the medium and long term, which has an impact through the following channels: a shrinking supply of (qualified) workers, a decreasing propensity to innovate and invest by an aging population, a higher tax and social security burden on companies in order to finance the pension system.

Since it is complicated politically, culturally, and economically to increase the domestic birth rate in the short and medium-term, the policymakers in Berlin should alternatively implement four approaches in the areas of immigration, education, robotization, and capital security: In addition to clear opposition to the mass immigration of lowly qualified migrants with a low integration ability, the federal government should campaign for the (re-)attraction of highly qualified skilled workers, which willing to integrate, especially in the MINT field (e.g. through a simplification of the visa regime and of work permits, as well as the recognition of foreign educational certificates).

In connection with the reduction in the supply of labor, it is necessary to increase the productivity of every employed person. This can be stimulated by giving skilled workers tax advantages depending on their level of qualification, while simultaneously providing state support for dual in-service training and life-long education.

In order to increase domestic company productivity without mass immigration, it is furthermore necessary to implement various tax preferences and other stimuli to convert the traditional risk-averse savings affinity of the Germans into more investments into robotization, automation, digitization, and AI.

At the same time, the outdated pension system based on pension contributions needs to be transformed into a funded, share-based pension system (i.e. based on a national wealth fund or “citizens fund”).

A crucial horizontal aspect of industrial policy, it is necessary to promote an increase in R&D expenditure up to 3.5 percent of GDP by: removing bureaucratic restrictions on research and the commercialization of scientific results at universities; tax refunds and other bonuses for R&D spending; supporting technology transfer, data sharing, and collective industrial research; the decline in selective direct project financing in favor of technology-open and ideology-free institutional financing; as well as the creation of top European universities in cooperation with other EU member states.

The German export-oriented industry is the biggest winner of globalization and the development of comparative advantages due to the dismantling of international trade barriers. The rise in unilateral and collective protectionist efforts (“slowbalization”), not only on the part of China and the USA but also on the part of the EU, must therefore be viewed with concern.

As an alternative approach, Berlin and the EU should advocate compliance with free trade principles, including: reform and strengthening of the multilateral WTO system; revigorating or starting free trade initiatives with the United States, the Eurasian Economic Union, the African, Mercosur, and ASEAN; the exit from sanctions against Russia and Iran; not implementing the potential supply chain law (Lieferkettengesetz) and the carbon border adjustment; negotiating export and investment freedoms for German companies on the Chinese market. In relation to the stability of production chains in strategic goods, the government should focus on stockpiling instead of protectionist reshoring policies. Overall, German foreign trade policy should focus on incentives rather than on bans.

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