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No Cat Behind the Grin — Post-Industrial Germany

Made in Germany was once considered a hallmark of quality — and it probably still is. But there are less and less goods that can claim to be made in Germany. Some may claim to be Assembled in Germany. But more often, we will find Made by Boche AG or, ominously, Made for Boche AG.

Made by Boche AG indicates that the good was produced by Boche's affiliate perhaps in Spain, Outer Mongolia or Wulustan. Made for Krause AG simply means that Boche purchased it from an OEM manufacturer, branded it and resells as its own.

In this, German companies are paralleling the example of U.S. companies which have outsourced production to China, Korea, Mexico, Malaysia and many other low-wage countries.

The owner of a small textile factory in Plochingen producing sweaters recently told his staff that he was discontinuing production in Plochingen because he could have the sweaters made more cheaply abroad. Some 85 people were fired; one manager was kept for a few months in order to close down and sell the factory.

During this period he was sent to Bulgaria to visit the new supplier and check on the quality of their product. He was highly surprised to find the factory equipped with the most modern looms. "How many hours a day are they running", he inquired. The answer was "Between two and eight hours, according to the level of orders."

He was even more astonished: "Our looms were working twelve hours a day in order to break even." The Bulgarians laughed. "We don't have this problem. The looms cost us nothing; we got them free from the German development assistance. It does not matter how many hours they are running."

One example among many. The German garment manufacturers are now producing 80 percent of their merchandise abroad.

What remains in Germany is a skeleton company in charge of marketing, finances and accounting, and perhaps R&D. But even this skeleton is gradually being globalized. Data processing and accounting are handled in India or Mauritius; software development is following in the same direction. Research and development can be performed much more cheaply than in Germany by developing country affiliates, as well as local universities and institutes. The remaining management and marketing unit in Germany gathers all data produced by the affiliates abroad and keeps them in the dark about their commercial success.

Even this option of a dominating head office located in Germany is a best case scenario because fiscal and financial considerations might make it advisable to move the head office to a tax haven such as Delaware or Kanton Zug, or to a financial hub like New York or London.

What is in the end left over of Boche AG in Germany is the grin without the cat. Boche's products are still there on the shelves, commanding the public's respect and appreciation for a "German" product which only in name is still German. If Boche manages to maintain a modicum of quality and reliability, nobody will notice the fact that there is no cat behind the grin.

German managers have become even more globalized than their goods. Not only the staff of big companies but also many owners of small and often family run Mittelstand firms have sold off their German factories and offices and moved abroad, to Swiss cantons, to Ireland or Monaco, to Delaware or Cayman Islands — why not keep a vacation home in Germany and send the kids to boarding school there?

The young have understood the trend. Some 1.3 million Germans, four fifths of them highly educated, left Germany during the past ten years, according to Erwin Teufel, the chief minister of Baden-Wuerttemberg, a highly industrialized state. In the U.S., more immigrants are coming from Germany than from any other European country. Germans are the third largest group of immigrants, after Mexicans and Salvadorians. In 2002 alone, some 120,000 Germans emigrated, with an annual growth rate of ten percent.

The resulting situation in the German labor market is paradox. In engineering sciences, for instance, thousands of jobs cannot be filled because employers insist on hiring young people while, at the same time, unemployment rates for engineers over 45 have since 1985 spiraled by several hundred percent. The experienced are being laid off while the promising youth are leaving the country, possibly because of a prevailing bias against engineering and natural sciences and a stagnant economy.

The de-industrialization of Germany is progressing rapidly; its extent being concealed by marketing efforts to maintain the "German" image of products which have ceased to be German in all but name. According to the Chambers of Industry and Commerce, 18 percent of German companies have already moved their production abroad, and another 24 percent are in the process of doing so. However, de-industrialization is an inexact term because the ongoing process is much more comprehensive than that: it is a sort of de-economization. A large sector of the economy is moving abroad: factories, labs, offices, taxes, and all.

The progress in de-economization is faster in Germany than in other European countries because of unfavorable local conditions: high taxation, high labor, social and energy costs, lots of administrative and environmental red tape, and weak financial institutions.

Extrapolating these trends casts a shadow over Germany's future. The government at all levels — federal, provincial and communal — is close to bankruptcy. It is obliged to absorb the combined costs of re-unification and de-economization because of laws introduced in a remote pre-re-unification past when the economy was still booming and the numbers of needy people were negligible.

Over the last few months Germany has begun to dismantle the welfare, unemployment and social security systems which beggar the government at a time when progressive de-economization is reducing the tax base. Next year the first results will become visible when large sections of the population, feeling the squeeze, will gradually slip into poverty. Already, the level of personal bankruptcies is at an all-time high. Sharply reduced unemployment benefits and welfare payments, as well as a freeze and the introduction of taxation of social security benefits will hit millions of Germans — constituting in some regions roughly one third of the population.

How is Germany going to change? Prima facie not to the better. Large parts of the country will begin to resemble the current pockets of poverty: Berlin, the Ruhr rust belt cities, Bremerhaven, and most of eastern Germany. Roughly speaking, the future model of large parts of the German society will consist of one third of the population living on pre-earned income such as accumulated capital or retirement benefits and support from family members; one third of Germans would be working, most of them in a service economy which provides the population with goods and services that cannot profitably be imported and therefore have to be produced locally; and the remaining third of the population would live on welfare, unemployment and minimum social security benefits.

Social contrasts will obviously increase. There will continue to be a lot of conspicuous consumption (in summer in Starnberg, a posh Munich suburb, you can see more BMW and Mercedes convertibles than Volkswagens), as well as a lot of new poverty with its corollaries, a vast submerged economy and decaying public amenities and infrastructure.

In the long run, however, some improvements may be expected. Work morale will, by necessity, improve. Many people are already now ready to work longer hours, night and weekend shifts. They will accept shorter vacations and a deferred retirement age. People will also react more positively to on-the-job training proposals. Even privately, a paradigm shift is likely to reduce the still appalling levels of computer illiteracy and reluctance to face and adopt technological change.

The new poverty will also force people to become more flexible in geographical terms and in the choice of jobs. Moving within the country and abroad in search of a job will require not only flexibility but also better knowledge of languages. For many, English will become more important than German, and schools should adapt to this requirement.

In the short to medium run, things are looking pretty bad for Germany. In the long run, however, Germans will probably accept the challenge and muddle through.

Germany's industry, although shrinking, will not disappear altogether. In addition to what is needed locally for serving the population, a few sectors will remain largely unharmed: most language-related activities such as media and book publishing, as well as most geographically focused activities such as agriculture, mining and tourism.

Industries which are neither labor- nor tax-intensive are likely to stay in Germany. A few industries using expensive high quality materials will, for instance, maintain their production in Germany because labor only accounts for a small fraction of their total costs.

Automating production is an elegant way by which German industries are avoiding two major problems: labor and taxes. Blessed by low interest rates, German companies are investing in automating rather than expanding prodution. The lower the interest, the more workers will be diplaced by automation in both factories and offices. Automats have four distinct advantages over workers: they are not unionized; they don't get sick, don't want vacations, and don't go on strike; they don't claim seniority benefits; and their investment costs can be written off. Small wonder that Germany is the world leader in automation, after Japan.

However, the government, always eager to find new sources of revenue, will soon discover that there are three types of potentially taxable work force: labor, hidden labor, and automats. Recently, the German government has launched a major legal and policing attack on illegal or "black" labor in which millions of Germans and illegal immigrants are active. How successful this attack will be depends less on the vigor of government action and more on the restrictions and overheads of official labor which create the "black" labor market. In the worst case, attacking the illegal labor will only create more official unemployment since many of the "black" workers are jobless people who are too proud to claim unemployment benefits.

From chasing the illegal workers there is only a small step toward attacking the third, and most competitive, labor force: the automats. Trade unions would certainly love to have the government slap heavy taxes on labor replacing gear from industrial automats to computer software.

With continuing progress in (still tax-free) automating production, some German industries will even return from low-wage countries, especially if generous tax holidays and other grants facilitate their repatriation. Germany's geographical position in the center of the expanded European Union and the size of its market will continue to attract foreign industrial investment.

On the negative side, de-industrialization is a one way street. Outsourcing production to low-wage countries is creating a technology base there. Whether in maquilladoras in Mexico, in sweat shops in Guandong or sweater factories in Bulgaria, workers are becoming better qualified. Millions of ambitious young engineers and computer specialists are graduating from internet linked universities and training institutes in developing countries, eager to rise to cutting edge levels of proficiency. Hard working and creative, they are serving the new industries in their countries as inexpensive R&D staff.

After a few successful years of learning experience as OEM manufacturers for Germany and other countries, these industries will launch their own brands and invade rich country markets. Made in China, Hecho en Mexico or Made in Czech Republic will increasingly replace Made in Germany or Made in Japan, with hardly any regrets on the part of the consumer. The ACER computer manufacturer in Taiwan, for instance, rose from modest OEM beginnings to the rank of the world's second largest producer of computers.

During the 1990s, the perception was that dirty and labor intensive industries would move from Germany to low wage countries, and Germany would instead create new, fancy hi-tech industries which are clean and more profitable. The burst of the E-economy bubble has dealt a bad blow to this perception while more and more fancy hi-tech industries are now emerging in developing and transition economies.

The rapid progress of some countries from dirty 19th century style industries to modern technology is quite breathtaking. These countries needed only a few years to master change for which countries such as Germany required decades. Internet access to top science and training in advanced technology provided by foreign companies and their expatriate staff are the main sources of progress. Also, these new industries are able to beat Germany and perhaps even Japan in their historic domain: quality. Whereas quality control in Germany suffers from high labor cost, industries in developing or transition countries can afford to allocate a considerable part of their labor force to quality control.

For the time being, Germany and with it the Euro Zone have positive trade and payments balances. Despite current industrial emigration and repatriation of the final product, Germany is still far from the situation of the U.S. economy which is heavily indebted to China, its largest creditor, because of importing so many goods produced in China mostly by U.S. companies.

Two countries are currently the Euro Zone's main export markets: the United Kingdom and the United States. In both cases, the rise of the euro exchange rate is already slowing down exports which, however, is less likely to affect Germany because of its success in penetrating Eastern European markets.

But Germany's positive trade balance might suffer when newly impoverished consumers abandon costly German brands in favor of cheap imported ones, a trend which is already visible and which will become much stronger in 2004 when the EU is forced to abandon many import quotas. The Germans, once known to be brand conscious quality shoppers are quickly becoming a nation of dedicated bargain hunters. Some 80 percent of the population are -— at least occasionally — shopping in discount stores.

America's ubiquitous dollar stores, which could with some justification be called "China" stores, have not yet appeared in Germany. Let's wait what will happen in 2004 and thereafter, when Germany's reform of its social institutions will be shifting into gear.

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—— John Wantock