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Germany's Search for Direction

(originally published by Booz & Company)

In a fascinating look at national psychology, the author attributes Germany's post-World War II economic miracle to a profound but motivating pessimism, and finds the country's recent economic difficulties accompanied by a show of unwarranted optimism. Noting the Government-inspired nature of these countervailing mood swings, he draws a promising parallel with the United States by concluding that corporate Germany ¬ like corporate America in the 1980's ¬ is working to put the economic miracle back on track.

"Germany's industry is far too skilled and impressive not to be able to regenerate itself," says the author, who praises the ability of many companies to succeed in the face of an inherently strong Deutsche mark and near-exorbitant social costs. Companies are beginning to downsize and globalize more aggressively, directing investment flows out of Germany in search of lower costs and moving their global production portfolio onto a level commensurate with the country's ranking as an economic power.

A coincidental and beneficial outcome of Germany's corporate job-shedding has been an improvement in relations between German companies and the Securities and Exchange Commission in the United States. Many companies have been financing their downsizing by calling on their hidden reserves, an accounting item long frowned upon by the S.E.C. Now that these reserves are dwindling rapidly, the door to Wall Street is opening much wider as exemplified by the much-heralded Big Board listing of Daimler-Benz.

The new operating procedures guiding the corporate sector signal a significant belt-tightening for German society, and one question that remains is whether Germany's "wait-and-see" political leadership is ready to embrace a new dawn. How much longer will it take, for example, to acknowledge the folly of receiving higher pay and higher benefits than all of Germany's competitors? Rediscovering this and other old truths will be good for Germany, and for Europe as a whole, the author says. In the meantime, corporate Germany is busy chasing the American dream.

Germany's vaunted economic engine has been sputtering of late. But while the country's politicians continue to debate what to do, its business leaders have rolled up their sleeves. There is plenty of repair work to go around.

For most of the post-World War II period, German business was driven by a peculiar sense of economic pessimism. Germans specialized in talking themselves down -- only to surprise themselves, after much hard work, by finding that things were not bad at all. In fact, they were in much better shape than anybody had expected -- inflation was held in check, growth was robust. The populace lived well. Each year, they repeated the process, looking gloomily into the future and performing beyond their hopes. Perhaps more than anything else, this self-motivating mechanism was responsible for the long-running German economic miracle.

These days, though, the bloom is definitely off Germany's economic bud. One could even speak of a remarkable role reversal between the United States and Germany. Traditionally, the United States has been thought of -- even derided -- as a nation of "economic optimists," prone to displaying a favorable outlook even when the forecast was not actually warranted by events in the real world.

In recent years, however, much of the debate in the United States about the condition of the country's economy has had a negative undertone -- despite the fact that things are actually going quite well, as the most recent numbers indicate. Indeed, there is growing evidence that Americans are fast turning into absolutists when it comes to judging their own performance. After all, compared with virtually all other major nations, the United States alone has embarked on a course of fiscal consolidation and structural change in the economy that is truly impressive. Its companies have achieved remarkable results, almost across the board.

Germany, on the other hand, has become more "American" in the sense that its Government lately has been painting a rosier picture of economic growth and other key performance figures than is warranted by events. For example, after declaring firmly all year long that in 1995, Germany would be the only major European country to fulfill all the tough criteria for currency integration under the Maastricht Treaty, the Government had to make the embarrassing concession that it had actually missed the budget deficit target of 3 percent of gross domestic product by seven-tenths of 1 percent. This year, Germany will not be able to fulfill the Maastricht target either. In a country with a reputation for fiscal solidity, these misses were significant, especially since the traditionally over-optimistic United States saw its budget deficit decline by 1.2 percent of G.D.P. in the same time period.

The Never-Ending Talk Show

One indication that the Germans' national economic character has changed is the fact that they have merrily debated for many years the need to change. As can be expected, the catalogue of reform items is comprehensive, ranging from longer business hours for retail stores to lower corporate and individual income taxes to bringing social benefits in line with those of other nations. Truth be told, if one examines the speeches made by German politicians, they are full of references to "we must (do this)" and "we must (do that)." The phrase is used so often that the mere sound of those words has become absolutely numbing to German voters.

Yet, in sharp contrast to the United States, one finds precious little competition among these politicians when it comes to spelling out how to realize all these lofty goals. In particular, the German debate surrounding the raft of restructuring issues is remarkably devoid of specific numbers. It tends to stay on the philosophical level. To make matters worse, the ensuing public discourse is entirely predictable. As soon as anyone tries to raise a novel idea, something that might actually crack the ice a bit, a chorus of naysayers rises, criticizing the reform-minded spirit for the political incorrectness of his or her thought. Obviously, as long as this peculiarly German proclivity toward non-specificity and mere role-playing lingers on, one can expect little real change.

Change Happens Elsewhere

To be fair, all around the globe, the world of politics is not a leading but a lagging indicator when it comes to assessing the prospects for economic reform. During the infamous "C" (as in competitiveness) debate, which captured Washington so completely during the second half of the 1980's, very little real change was brought about by Washington itself in the end. But, fortunately, corporate America felt itself very much gripped in the claws of a crisis -- and acted accordingly. Due to a happy coincidence, these two time lines -- one concerned with the debate in Washington and the other focused on real change on factory floors and in management suites throughout the United States -- were on parallel tracks. As a result, many of America's presumably "doomed" industries, such as semiconductors, are very much alive today.

To quite an extent, the same process is now going on in Germany. That is one reason why it would be a grave mistake to count the country out from the global economic game. As was the case with the United States, Germany's industry is far too skilled and impressive not to be able to regenerate itself. German companies are shedding jobs, going beyond the rate of attrition as best they can. To this end, many leading companies have been aggressively using their hidden reserves to finance early retirement schemes to reduce the head count. That course is extremely expensive in Germany, but given personnel-heavy cost structures, the companies feel nevertheless that it is worth the effort.

Coincidentally, this process of rigorous job-shedding -- in essence, by "sponsoring" an entire generation of middle managers to take early retirement -- has also had interesting effects on the attitude of Germany's leading companies toward the American financial market. Traditionally, in German eyes, the biggest obstacle on the road to listing a company's shares on the New York Stock Exchange was the tough stance that the Securities and Exchange Commission took with regard to German accounting standards. The question of hidden reserves was one of the thorniest -- if not the thorniest -- items on the agenda.

It is a key irony in the ongoing process of the globalization of finance that the friction between German companies and the S.E.C. is decreasing in line with the domestically induced need of the Germans to melt down those hidden reserves to reduce the head count. Case in point: Daimler-Benz -- one of the citadels of German industry -- made its pathbreaking trip to Wall Street when its own change process was well under way. In addition, the company's senior managers saw a need for the global sourcing of equity capital in order to insure cost-efficient access to new financing. Of further benefit to them was the fact that investors in American capital markets have an appreciable appetite for companies interested in tapping new capital for the purpose of consolidating -- rather than expanding -- their business.

Multinationalization, at Long Last

Another way in which Germany's current adjustment process can be easily misread relates to the spate of recent reports about a heavy outflow of direct investment. To an extent, this situation is indeed worrisome, largely because there is very little corresponding inflow of foreign direct investment to Germany. On the political stage, the problem has become so severe that even politicians from the ranks of the Social Democratic opposition are now calling for tax holidays for any new investors from abroad.

At the same time, one needs to be aware that, for all its many successes in the past, Germany's integration in the global division of labor was surprisingly limited. By and large, most of its corporate success stories were based on the rather antiquated model of exporting companies. But when it came to examining Germany's production stance outside its home market, very little turned up on the radar screen. In that sense, a large part of the current adjustment gripping Germany is not so much a function of any decline, but of the fact that its global production portfolio has finally moved onto a level that is commensurate with the country's ranking as an economic power.

This relocation process extends far beyond Asia, where an appallingly low 2.5 percent of Germany's total foreign direct investment is located.

As a recipient of a considerable part of the investment outflow from Germany, the United States is an important beneficiary of this globalization trend. While Germany's chemical companies -- as the only exception to the rule -- have long had a respectable portfolio of facilities in the United States, now the leading car companies and other German businesses are -- finally -- following suit.

By the same token, the bad news this outsourcing of production represents for Germany's workers spells good news for the economic fortunes of the country's neighbors in Central and Eastern Europe.

Poles, for example, nervously ask whether corporate Germany will keep them "on board" -- or all of a sudden get rid of them, say, to make room for more jobs for Germans. But what they do not realize is that they are, in effect, asking an economically illogical question. Given Germany's cost structures, the rapid integration of more and more sources of supply from its eastern neighbors is not a nice "add-on" thought -- but the very precondition of Germany's economic survival. Only to the extent that German industry proves very skillful in moving its products down on the cost curve will it succeed globally.

In this context, one thing becomes clear: considering the double load of an inherently strong Deutsche mark and of near-exorbitant social costs, it is impossible not to appreciate the ability of the many German companies that have managed to succeed with production at home despite what would seem to be overwhelmingly negative odds. This is a significant testament to the country's management and technical skills.

Germany Is No United States

At this juncture, however, the end of the road of internal corporate adjustments may finally have been reached. Now, there seems no escape from tackling some of Germany's systemic deficiencies in the social policy arena.

But in undertaking this process of adjustment, Germany has to deal with a major disadvantage compared with the United States. Germany is really too small a country to engage in a policy of much wage differentiation. One of the more impressive features of United States economic performance in recent years has been that companies such as Motorola -- and even textile manufacturers -- have managed to bring jobs back home. Aside from the general desire to move closer to the customer base for demand management and customization reasons, one precondition of this "home-shoring" (as opposed to off-shore production) is that, in many areas of the United States, a worker can live reasonably well making less than $10 an hour. In Germany, a much more densely populated country, that is not really an option.

Companies Vs. Society?

Irrespective of the adjustment potential of German industry, how well a society -- in contrast to a nation's companies -- will cope with such profound change is an entirely different matter, as we all learned from the United States.

Companies can relocate, but it is much harder for people to adjust. As was the case in the United States, the transformation process requires a massive shift of resources from the manufacturing to the services sector. Often this shift results in lower wages, forcing people to adjust their economic behavior patterns accordingly. In many ways it is a transformation that is almost as grinding to us "Westerners" on the individual level as is the transformation process in Eastern Europe.

In this context, one of the most significant effects that will truly hit home hard over the medium term is the belated "multinationalization" of German industry. First and foremost, its consequences will become apparent in the tax arena. The recent recession has already left many of Germany's heftily taxed corporate "star performers" -- like Daimler-Benz -- carrying large amounts of carry-forward losses, which they will offset against future profits. For the Finance Minister, that translates into lower tax revenues for the medium term.

But the real "taxing" effect on German society stemming from the trend toward multinationalizing the country's export economy will occur even in so-called good years. Multinational companies have many options when structuring their tax payments, preferring to file in those places where it makes "business sense." By that standard, Germany is about the last place where it makes sense to pay taxes. Two years ago, BMW provided ample illustration of what Germany as a society has waiting for it. Even though the company managed to turn in the best performance in its history in terms of earnings, it also succeeded in paying less tax in Germany than ever before.

Consensus -- or Indecision?

Under these new operating procedures guiding the corporate sector, German society is in for a significant round of belt-tightening. With all due respect to Chancellor Helmut Kohl -- undoubtedly a political leader of historic importance for Germany, if not Europe -- he has his critics when it comes to economic policy. Plainly put, they ask whether the "sumo wrestler," as President Clinton once jokingly called him, really has it in him to be the leader for this belt-tightening exercise.

On that road, perhaps the greatest test ahead for Germany concerns the viability of its famed predilection for consensus. Again, there are those critics of the Chancellor who claim that he has had an incredible tendency to adopt a "wait-and-see" attitude on basically all matters of economic policy. What has dumbfounded -- if not paralyzed -- his critics, though, is the fact that his instincts have, time and time again, proved better than their forecasts and analyses.

The key question now is whether this peculiar German miracle will hold up. There are some ominous signs. For example, Hans-Olaf Henkel, the head of the Federation of German Industry, recently spoke with great concern that "debate, forever debate, but no action whatsoever" is becoming the country's new national sport.

These warning signs are very real. For years, it has been downright amusing for this United States-based German author to shuttle between Bonn, the capital, and Frankfurt, the country's financial center. Due to the two cities' proximity and my complicated schedules, this trip back and forth might on occasion be made as often as twice a day. So it was particularly striking when, arriving in the political capital, I would be greeted by a senior Government official with these words: "Now, you are a decent chap, but I know you have just arrived from Frankfurt. Let me ask you, how can you possibly get along with these weird financial types?" Arriving back in Frankfurt, the corresponding welcoming lines would go like this: "We like dealing with you. But we know you are also consulting people up in Bonn. How can you stand these political and bureaucratic types?"

In light of such discordant dialogue, it surely felt strange to come back to Washington and hear very respectful references to Germany along these lines: "What the U.S. really needs is some German-style spirit of cooperation and consensus between Government and the private sector."

Fundamentally Different?

To be sure, Germany's leaders in politics and business alike do not much care for this story -- maybe because it touches too many raw nerves. And yet, the lesson that these leaders probably need to learn the most is that, for once, their customary "magical" response mechanism -- where all wrongs could be righted in a single year -- may not be sufficient. Since the 1950's, it has become a well-established pattern in Germany to expect that other countries, including the United States, might well fall victim to an overheating of the economy or to a recession. Whenever these economic partners took several years to get back on their feet, it seemed that Germany, for some mysterious reason, needed only one year.

The trouble is that Germany as a whole seems to have come to rely on this magic as if it were a bankable asset. Instead, as they prepare for the new century, Germans may find themselves faced with a rapid end to their "uniqueness" doctrine.

Just last year, Germans thought for a while that they had done it again. While the United States has had to cope with declines in real income for a period of almost 20 years, the Germans were proud of the fact that they had solved the problem in just one year, 1994. Once more, the magic seemed to have worked. The German economy was getting back into shape, or so it seemed, as the unions were busy redistributing income gains from productivity increases that were yet to be realized throughout 1995. Similarly, industry was busy making concessions yet again -- all for the vaunted purpose of preserving the "social peace." In 1996, however, that magic has stalled -- and German employers are, ever so slowly, relearning the game of behaving like capitalists by daring to say no.

The jury is still out on whether this basic mission is being accomplished. Nevertheless, the insight into global economic realities is spreading. Germans, and most West Europeans along with them, are beginning to stop looking down on the economic processes that took hold of America in recent years. They are starting to grasp the fact that America's much-maligned 1980's may, in the end, have a lot in common with Europe's late 90's.

Europeans are beginning to see that what was supposedly wrong with America back then was, in reality, a sign of something going right. Indeed, what America accomplished during the last decade -- at great domestic pain, but to the country's lasting credit -- was a corporate reordering that got it ready for the full-blown globalization of the world economy. In that sense, the United States is the only major industrialized country that has maneuvered itself into such a cost position that it can successfully compete all around the globe.

That task still lies quite a bit ahead from where Europeans currently see themselves. In fact, if travel patterns could be regarded as a leading indicator for the willingness to undertake domestic economic reform, then most Germans -- the world champions of world travel -- are still mired in an outright escapist mode. It is as if they would like to go out and about for one last time -- before they are forced to stay home for the arduous work of years of belt-tightening exercises.

The Power of Basic Math

And what will the Germans learn in this process? Most likely, they will rediscover something fairly plain: the power of basic math. For example: you cannot really have it both ways! Receiving higher pay and higher benefits than all of your competitors does not go down well. Unless you suppose there are genetic differences that might account for economic performance, the benefits/pay issue remains very much an either/or type of proposition. For all of Germany's much-vaunted productivity, you simply can't have more vacation -- and other higher benefits.

Another insight waiting for Germans in this context is that whatever you grant yourself as a benefit has to be related in some way to what others are doing. If other countries cut costs, how can you get by without doing the same?

Rediscovering these old truths will be good for Germany, and for Europe as a whole. Obviously, the current noises about the end of the welfare state that are trumpeted with so much bravado throughout the United States are an exaggeration as far as that country is concerned. But in Europe, the welfare state has definitely gone too far -- and urgently needs redressing.

In assessing whether Germany leads (as it traditionally has) or lags in this process, a crucial dimension of the "EU-ization" -- or, indeed, the "EMU-ization" -- of the European economy comes into play. In the effort of standing up to the Bundes- bank's stellar reputation, other members of the European Union have learned that the financial markets look for real performance measures as a cushion against imposing high interest rates on other countries. As a result, Germany will have to learn the lesson that it, too, must ease its interest rates on the basis of actual performance, rather than on the mere reputation.

The Advantage of Not Being German

It was a brutal lesson, and one not lost on Germany's EU partners. In fact, it seems as if they have some advantage in not being Germany. As each of these partners examines the global economic stage, it can use two measurements to gauge its own success. The first is a distant one: How are we doing in light of the Asian challenge? But, to their good fortune, the partners also have a challenge much closer to home: How are we doing compared with the Germans? What can we do on taxes, on social costs, on regulation, etc., to outmaneuver the European heavyweight? That is a distinct advantage for which the Germans urgently need to find some proper form of simulation.

One thing, though, will not do. Call it the "creeping Italianization" of the German economy. One telling example of what is meant by that phrase was provided by the chief economist of the country's leading Mittelstand bank during a panel discussion about Germany's future performance. In assessing a colleague's review of the country's prospects, he stated emphatically: "But you are understating the effects of the shadow economy. It has quite an effect on G.D.P. growth."

Likewise, critics of German fiscal policy are often kept at bay nowadays with a pointed remark -- even from within the top levels of the Bundesbank -- that "Italy's performance in this field is far worse."

Ten years ago, no German would have dreamed of making such a comparison. Back then, Germans were still absolutists. That they have abandoned this stance is not exactly an indicator of a noble European mind-set.

Illustrations by Michelle Longee

Reprint No. 96407

Stephan-Götz Richter,
Stephan-Götz Richter is publisher and editor-in-chief of The (, a leading Web-based daily magazine covering the global economy. A weekly columnist for the Financial Times Deutschland, Mr. Richter has written for the New York Times, the Wall Street Journal, Foreign Affairs, South China Morning Post, Le Monde, and other publications covering world affairs.
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