Peter Franklin

Peter Franklin is Associate Editor of UnHerd. He was previously a policy advisor and speechwriter on environmental and social issues.

October 9, 2019

If you believe that a ‘real’, honest-to-goodness economy is all about ‘making things’ — then I’ve got some bad news: in almost every country in the world, services are bigger than industry. Even in China, the greatest industrial power in human history, industry accounts for about 40% of GDP — well behind the service sector.

In richer economies, industry’s share (itself composed of manufacturing, construction and resource extraction) is much smaller — approximately 20% in America, Britain and France. In Germany, though, it’s significantly bigger at around 30%. This is unusual for a major western economy — especially one without a vast hinterland full of natural resources (like Canada or Australia).

When you consider that Germany’s export-led economy also lacks the ‘advantage’ of low labour costs, you have to wonder how they do it. The country’s high tech, high skill, high wage manufacturing sector is a wonder of the global economy, the engine room of Europe and a force for stability in German politics. Which is why its sudden downturn has caused widespread concern. Is this a sign of impending recession – not just in the Bundesrepublik, but across the EU and beyond?’

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Writing for Bloomberg, Chris Bryant argues that in some ways it might be worse than that:

“So far the problems aren’t nearly as acute as in 2009; industrial production fell by a comparatively modest 4.2% in July. The worry, though, is that demand is being sapped by a mix of both cyclical and longer-lasting structural factors…”

What structural factors?

The biggest one is technological. The future of the automotive industry is electric, whereas the dominance of the all-important German car industry is based on its mastery of the internal combustion engine. The great shift to electric vehicles is the most disruptive change to the industry since the advent of the production line.

Vorsprung durch Technik? Absolutely, but if you change the Technik you restart the race — and that gives manufacturers in other countries a chance to steal a march. It doesn’t help that it’s not long since German industry took a huge bet on diesel engine technology. Thanks to Germany’s clout in the EU, plus blatant falsification of emissions tests, most of Europe was drawn down the diesel route. It was a disaster for air quality and thus human health, but it’s also proving to be a slow-burn commercial catastrophe. Political and consumer opinion has turned against diesel, which now looks like a dinosaur technology, its extinction in sight.

The fatal miscalculation is compounded by the fact that battery electric vehicle technology is progressing rapidly, with governments setting deadlines for a complete transition to low carbon transport. Indeed pressure is building to bring the deadlines forward.

Of course, it wouldn’t be the first time that industries have failed to predict disruption. Think IBM and the personal computer and Kodak and digital photography. However, in those cases there were other companies in the same industries and countries ready to ride the wave of change, plus a ruthlessly competitive business culture that allowed the new to replace the old.

German industry is different. Its strength lies in tightly interwoven supply chains and close collaborative relationships between business, finance and government. That can work very well in normal circumstances, but not in times of disruption when what is required is speed and agility. Some companies will adapt, a lot will be left behind – especially those that have evolved to fulfil specialised roles in long-established supply chains. Chris Bryant, again:

“…the German carmakers BMW AG and Daimler AG have issued profit warnings as tighter emission rules oblige them to keep spending heavily. Their suppliers are the ones really hurting though. At least three — Eisenmann, Weber Automotive and a subsidiary of Avir Guss — have filed for insolvency in recent weeks and investors are betting the pain will spread more widely…

“The company that best illustrates this slow-burn crisis is Continental AG. Last week the tire and car parts titan announced a massive restructuring, which it said would affect 20,000 jobs over the next decade, or some 8% of the workforce. Explaining its decision, the manufacturer warned of an ‘emerging crisis in the automotive industry’.”

Even if the German car industry fully adapts to the electric engine, things will never be the same. The fact is that the new technology is a fundamentally different beast — not only in terms of its energy source, but also its simplicity. As Bryant reminds us, “electric vehicle drivetrains have far fewer parts and the process is less labor intensive.”

In any case, I strongly suspect that we’ll see a long-term decline in demand for cars of whatever description. Electric and self-driving vehicle technology will revolutionise public transport and green-minded urban electorates are turning against the tyranny of automobile.

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More generally, an economy that’s fuelled on local supplies of polluting brown coal and Russian natural gas looks poorly prepared for the environmental and security challenges that lie ahead. And as for Germany’s once lauded Energiewende, that’s become a lesson in how not to transition to more sustainable energy sources.

There are non-technological challenges too. Let’s not forget that a great deal of Germany’s competitiveness is an artificial effect of the Eurozone — which pushes down the exchange rate at which German exporters trade, while artificially pushing it up for potentially low cost competitors elsewhere in Europe. Meanwhile the Single Market and Customs Union provide a protective shield against competition from outside the EU. However, the stability of this mercantilist super structure cannot be taken for granted. Brexit is the first crack in the foundations and others are accidents waiting to happen.

The UK’s departure will also reduce the contributions to infrastructure spending in southern and eastern Europe — i.e. Germany’s captive export markets (which also provide a source of cheap labour for German-owned local industries). Meanwhile, the Americans are calling for Germany and its neighbours make a much bigger contribution to their military defence. It’s a reasonable demand that can’t be resisted forever, but the end of sponging off America would mean higher taxes on German producers and consumers.

The most immediate threat, of course, is recession. With comparatively low levels of government debt, the obvious thing for the Germans to do is turn on the spending taps. The problem with that, however, is the Eurozone. If Germany starts splashing the cash, then other Eurozone members will demand the same freedom, starting with Italy. However, many of these countries have much higher levels of public debt, which through the common monetary policy of the single currency exposes Germany to unacceptable risks.

Brexity Britons may be tempted to enjoy that fine German export — a spot of schadenfreude. But we really ought not to. For a start we’re not out of the EU yet — and even if we do escape soon, there’s no escaping Germany’s influence on the global economy and the international order. Remember that our neighbour’s low unemployment and political stability depends on the continued success of its very special, but far from invulnerable, economic model.

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