Germany’s Economic Success Threatens to Stall Innovation

Angela Merkel urges other European nations to boost their competitiveness. So should take her own advice.

Hamburg, Germany, March 21, 2010
Hamburg, Germany, March 21, 2010 (Jürgen Stemper)

Germany’s economy is considered the engine of growth in a Europe recovering from sovereign debt crises but a special report in The Economist this week reminds readers that it took hard work for the country to get where it is today — and that there’s more to be done.

The British newspaper points out that in spite of lower growth figures than in Britain and the United States, Germany has managed “to avoid a surge of layoffs after the financial crisis and has done far better than others at getting the young and the hard to employ into work.”

Part of the explanation lies in labor market reforms that were enacted by Germany’s former, Social Democratic chancellor Gerhard Schröder in the early years of the last decade. His government eliminated payroll taxes on monthly earnings under €400, recently raised €50, encouraging part-time work. A flat rate benefit also nudged jobless Germans back into work.

The reforms, while successful, ended Schröder’s political life and the conservative Angela Merkel succeeded him in 2005. Germany’s Social Democrats now complain that she reaped the benefits of reforms that cost them the chancellorship. There’s some truth to that statement although Germany’s economic success has more structural causes as well.

One, The Economist points out, is the system of Mitbestimmung that gives labor unions a seat on company boards. That has kept wages down. Between 2001 and 2010, German wages rose by an average of 1.1 percent per year, barely enough to keep up with inflation. Unit labor costs rose only 5 percent in the same period, compared with 21 percent in Italy, while Germany’s workers, unlike Italy’s, actually became more productive.

Most explanations of the German miracle also heap praise on the Mittelstand model and the system of vocational training. Medium-sized firms, which form the backbone of the German economy, take on apprentices, mixing practical training with classroom tuition.

While that has kept unemployment low, it also creates, in effect, a closed shop. Germany’s federal government now recognizes foreign technical qualifications but only five of the states do. “Virtually the only route to many technical occupations is to join as a sixteen-year old school leaver,” The Economist laments.

The European Commission last month also singled out Germany’s qualifications system for one of its lengthiest policy recommendations, noting that in many industries, including construction, “there is still a requirement to hold a master craftsman’s certificate or an equivalent qualification in order to run a business,” keeping entrepreneurs and professionals with otherwise comparable skills out and the costs for consumers, as a result of lessened competition, high.

Regulations for especially small businesses are similarly hostile to new entrants, The New York Times reported in February of last year:

Though Germany’s chancellor, Angela Merkel, often harangues countries like Spain, Italy and Greece to become more competitive, the German economy features some of the same flaws that they do, including protected professions and zoning laws that favor existing businesses over new ones.

The OECD, a club of industrialized nations, estimates that Germany could add some 10 percent growth over the next decade if it removed such barriers to competition. “Surprisingly,” the American newspaper observed, “the untapped potential in Germany was almost as high as that in Italy and higher than that in Spain.”

It is high time Germany tapped that potential for The Economist knows that its economic success is not as robust as it might appear.

Merkel’s second government with the otherwise pro-business Free Democrats has enacted virtually no growth enhancing reforms in the last four years. Germany’s phasing out of nuclear energy and generous subsidization of renewables has produced energy bills for households that are 40 percent higher than is the average in the rest of the continent. “And it boasts the oldest population in Europe. Over the next ten years its workforce will shrink by some 6.5 million, the equivalent of all the workers in Bavaria.”

Germany must innovate if it is to preempt a crisis of demographics and in energy. It should make it easier to do business, remove burdensome regulations and subsidies that distort the market and relax certificate requirements that harken back to the medieval guild system — especially for migrant workers it needs in the coming years when the native population ages. In short, like the rest of Europe, Germany has to become more competitive.

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