Germany's Unexpected Economic Crisis

Germany is as famous today for its incredible engineering prowess as it is for big jugs of

beer, sausages and checkered history. Germany has recently become the third largest economy

in the world behind China and the USA after overtaking a stagnant Japan.

It's also clearly the most powerful and influential economy within the European Union

and a large driver of that economic success has been the country's ability to produce

extremely high-end manufactured goods. Of course there are the country's cars,

but that only makes up a surprisingly small share of the country's total manufacturing output and

an even smaller share of its exports. Germany really does live up to its reputation because

it has become a world leader in a vast array of different engineered goods from aircraft

and medical devices to centrifuges used in nuclear energy. Basically if there's something

that really needs to be made right there's probably a German factory making it, or at least

there was. A long list of internal and external challenges have put significant pressure on German

industry to the point where a lot of economists and commentators are predicting that the country

could lose its industrial dominance entirely. That is a big claim that would represent a

significant shift in national, regional and frankly global trade. But even if it does come true it may

not be as bad as it sounds for the world's third largest economy and to find out why we must as

always answer a few important questions. So why are economists predicting the end of Germany's

industrial dominance? Why is this happening now? And finally why could this actually be a good

thing for Germany?

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today. As the world has opened up to more global cooperation where goods and services are traded

more freely between countries across the world, there's been a general shift towards countries

doing what they do best. A country like China has an enormous and relatively industrially capable

population, a decent global position for trade, and a political system that has been very

accommodating of rapid expansion so it has become a global center of low-cost manufacturing.

Singapore has a tiny landmass and a relatively small population, but it has developed a very

robust political system and it's right in the middle of the world's busiest trade route so

it has become a highly competitive business and refueling destination.

These economic features lead to something called comparative advantage. No matter how hard

Singapore tries it just doesn't have enough landmass or manpower to compete with the industrial might

of China. Likewise, without radical changes in the way the country operates, no international

businesses will move their operations to China because it represents significant political risk.

So this means that China has a comparative advantage in producing basic manufactured goods

and Singapore has a comparative advantage in producing financial services and operating as

a glorified servo for the world. So long as these countries remain more or less cooperative with

one another these strengths and weaknesses are fine because Singapore can buy cheap consumer

goods from China and Chinese shipping companies can use Singapore as a gas stop or a place to

manage international finances. On an individual level in our own economies we have grown wealthier

by specializing in roles that we do really well and letting other people do the same and then just

trading with one another. Most people don't know how to do surgery on themselves but that's okay

because they can pay doctors to do it with the money they've made from their own specialized job.

Free trade and taking advantage of comparative advantage lets entire national economies

effectively do the same thing, which theoretically should be great. Highly specialized roles in

modern economies are one of the biggest reasons that the world is so wealthy today,

but there can be issues at a national scale. On a personal level within economies, especially

advanced and politically stable economies, there are authorities and institutions in place to

settle disagreements. On a global level there really isn't the same thing. There are mediators

like the world trade organization and the UN, but if a country decides to cut another country

off from trade then short of declaring war on them there really isn't much that can be done.

This whole issue with holding a valuable place in global trade while not being overly reliant

on it is especially important in Germany because of its unique advantages.

Germany has a highly skilled workforce, especially in engineering and manufacturing disciplines,

a decent geographic position within Europe and has over the past few decades had access to very

cheap energy. This gave it a strong comparative advantage in producing high-end industrial goods.

Normally when people think of gaining an economic advantage in manufacturing,

they think first to lower the cost of the labor force so factories have to pay their

workers less so they can make things cheaper overall. This is why places like China produce

so much of the world's stuff, but as wages in China have increased, global manufacturers are

looking for cheaper alternatives in countries like India. Now Germany is home to some of the

highest-paid workers in the world, so on the surface it doesn't make sense how it remains

competitive with cheaper global centers. But depending on the type of manufacturing,

labor costs are not as important as one might expect.

Most German industry relies heavily on either highly advanced machines and tools to assist

with production, or they are producing something so valuable the difference between paying someone

$2 an hour to make it versus $50 an hour effectively makes no difference to the end price.

German car factories use a lot of automated machines, with just a few highly skilled

workers using those machines to make 100 times as many cars per worker as they could with basic

hand tools. At that scale, paying highly skilled German workers more has been competitive because

the advantage came from having the machines and the experience to use them, rather than having

the workers that would work for the lowest possible price. If this is compared to the

type of products that countries like China typically produce, they tend to be put together

with more basic tools and a lot of hands-on assembly. There are of course German cars that

are also made by hand, but they tend to be extremely valuable, where the end consumer

is willing to pay a premium to have a car that was hand-built in Germany.

And that right there has actually been one of the biggest factors contributing to Germany's

comparative advantage in manufacturing, and that's its global reputation.

An even clearer example of this would be products made by a company like Siemens,

ok yes, terrible name to put in a youtube video, but still one of the country's largest manufacturers.

They produce things like nuclear centrifuges and everything that goes along with them.

These machines cost hundreds of millions of dollars to produce and install,

and it's the type of thing where not only would the reputation of German engineering go a long way,

it would be the kind of thing that only Germany and a handful of other countries

around the world would be allowed to produce without causing geopolitical tensions.

The labor costs of machines like this are barely a rounding error,

so the high cost of German workers isn't really a problem.

Other input costs, especially energy are more important for the highly mechanized

industry taking place in Germany. Now in the past this has actually been

one of the country's biggest strengths. Since the mid-1990s it has been able to

pump very cheap natural gas directly from Russia and Norway, which have some of the

largest reserves of this energy source in the world. Now clearly there have been troubles with

this in the last two years, and higher energy costs are having a bigger impact on German

manufacturing than higher wages ever really could. And that's only the first thing pushing

the shift away from Germany. The energy crisis hit a lot of German

businesses particularly hard because the country is still so dependent on cheap fossil fuels

to power factories that use an incredible amount of energy.

But German manufacturing has been in decline well before that already,

and this trend too can be explained by carefully exploring what contributed to

the country's comparative advantage to begin with.

It's incredibly talented and highly skilled workforce is aging, and thanks to generous

retirement benefits that are a key feature of the country's economic system, people are

leaving the workforce earlier than they might need to.

Of course on an individual level this is fantastic, people shouldn't sacrifice the

quality of their life for the sake of economic metrics, but businesses within Germany are

struggling with this. Now normally advanced economies can compensate for this by bringing

in skilled migrants from countries with lower standards of living, but Germany has struggled

with this too. Skilled workers just aren't as drawn to Germany as they are to places

like Australia, Canada, the UK and especially the USA.

Now part of this is just the language, English is a far more widely spoken first and second

language than German is, but there are other factors as well.

The high training standards that have contributed to Germany's strong manufacturing reputation

means that even workers that want to move into low-skilled roles often have to sort

through bureaucratic training certifications that can take years before they start working.

Whatever the root cause the results are the same, Germany is desperately short on manpower

with over 750,000 job vacancies in some of the country's core industries going unfilled.

Gaining a comparative advantage for the quality of its manufacturing has also meant that it

was only a matter of time until other countries caught up.

Today Chinese manufacturing is not nearly as far behind German manufacturing as it once

was. China is building cars, batteries, aircraft and advanced machinery that is

genuinely rivaling the stuff coming out of Germany.

Of course China still produces a lot of garbage products which is why it still has a bad reputation

for producing subpar goods, but it has demonstrated that it can genuinely compete in the advanced

manufacturing space as well.

Today there are more BMWs produced in China than there are produced in Germany,

and despite that metric perhaps being a bit of a national embarrassment,

it ironically enough highlights how one of Germany's greatest opportunities

is being hidden behind this seemingly bad news.

German companies can charge a premium over companies from other countries for their

manufactured goods because consumers perceive German-made goods as a high-quality alternative.

Whether that's true, well just ask anyone that's tried to maintain a Volkswagen.

But the reality doesn't matter, what also doesn't matter is where the goods are actually made.

People just see a German company and assume the goods were made in Germany.

If the predictions of German industrial decline are correct then what the country could do

is leverage its advantage of having a fantastic reputation for producing goods that are worth

paying a premium for, without any of the disadvantages of actually having to produce

them in Germany. Germany scaling back on its manufacturing is in many ways kind of overdue.

Compared to other advanced economies, even those that have their own large domestic

automakers and high-end manufacturers, Germany has about 50% more of its people

working in industrial jobs. These jobs can be made more productive by giving people working

them more advanced tools and technology to leverage how much work they are doing,

but there is an eventual limit.

A worker building a car by hand might take a month to put one unit together,

whereas a small team overseeing large industrial presses and robotic assembly arms could produce

a thousand a day, and since they produce more there is more room to pay them more,

which is why salaries in advanced economies are higher.

But eventually it becomes better for these workers to just move into service roles,

where instead of overseeing the manufacturing themselves, they spend their time setting up

infrastructure and training teams in other countries to do it for them.

The USA is the largest economy in the world today, in large part because it is home to

companies that do most of their operations overseas, but still bring in the wealth generated

from these activities back on shore. Germany has for the last three decades decided to do

stuff more in-house, but this shift away from domestic manufacturing is not so much a failure

of its industries as it is taking the next logical step for their advanced economy.

But that doesn't mean that there won't be major problems.

If this shift away from local manufacturing does continue,

it would represent a major shift in a major economy,

and any change that big is going to have consequences.

Workers across Germany are already protesting government changes to energy subsidies and

tax rules, and while this is mostly directed towards agriculture and transport for now,

it's a symptom of the shift in the way that business has been done in the country.

Germany has historically had very harmonious relations between workers and companies,

but that's because German workers are represented well by very powerful unions

and the economy itself is managed in such a way to protect workers rights.

This works while German companies need German workers, but if they can offshore a bulk of

their operations then it could undermine the highly egalitarian economic system that

modern Germany has been built on.

Even from the perspective of a purely cold-hearted macroeconomist,

only concerned with headline economic figures,

the shift away from domestic industry still could present risks.

Theoretically, the workforce could move into more productive and value-adding service roles

that make the country even wealthier.

But the move from a role where a worker is directly installing engines into a car,

to something like a role where they're training a foreign team to install an engine,

takes a different set of skills.

There's also no guarantee that this shift would directly lead to better jobs for Germans,

instead of just less jobs for Germans.

Installing engines may not be as valuable as training a new team to install engines,

but it does provide something to do so long as there are cars to be made.

Once a foreign team has been trained on how to do a German's job,

they don't really need the German worker anymore.

Beyond that, the reputation of a country is a lot like the reputation of a company,

individual, or anything really.

If German companies don't maintain their standards while setting up international operations,

they will very quickly lose the large group of consumers

who are willing to pay a premium for a good that is at least, theoretically, German.

Now, we did a comprehensive overview of all of the features of the German economy a few months ago,

so we wanted to just focus on the issue of shrinking industry in this video,

without repeating too much.

But if you haven't watched that more general overview,

you should be able to click to it on your screen now.

Thanks for watching mate, bye.