Germany has long been a formidable beacon of economic strength and stability for Europe. As a university student in the German-speaking part of Switzerland in the late 80’s, I was raised in awe of Germany’s prowess. The avant-gardist pop band Kraftwerk could be heard playing ‘Music Non Stop’ (1986) with a synthetic voice aptly broadcasting ‘industrial rhythms all around’. Only two years ago the country was seen as surfing economic and political waves, with an opportunity to lead a post Brexit European Union (check GoT’s Varys in ‘Shadow On The Wall’ in July 2017).
Today, the situation is rather different. In recent months, investors have been getting concerned about (i) a decline in export, (ii) uncertainty with respect to any fiscal policy response and (iii) the overall implications for domestic consumption. The malaise is reflected in economic stats: According to the Bundesbank, the country’s GDP is expected to grow by half a percentage in 2020, in line with 2019 – and that was right before the spread of the Coronavirus which is set to hit Germany harder than other EU countries given its significant reliance on the value added imported from China and embedded in its final products (2.3% of GDP). A recession is looming.
As often, the fundamental question is whether the woes are cyclical or structural in nature. I believe equity investors' focus on short term cyclical factors conceal deeper issues about structural trends. Indeed, Germany’s business model appears to be challenged on multiple fronts: technology, infrastructure and social cohesion, leaving aside poor demographics. To elaborate on the technology front, the Financial Times recently observed that Apple has the same market cap as all the DAX 30 companies combined. To add insult to injury, the country is seeing its pride attacked by a deluge of negative news related to its flagship automotive industry (5% of GDP vs. 3% for the U.S.) with Tesla rivalling Volkswagen in terms of market capitalization.
Germany’s historical hardware focus and true excellence in that field has weighed on its incentive to build world-class tech capabilities. It is a perfect example of the ‘Innovator’s Dilemma’ applied to a whole country. According to this widely observed phenomenon captured in a book by Clay Christensen (1997), rational industry leaders tend to be reluctant to invest in new technologies as they dilute their return on capital without moving the needle from a revenue perspective. In fact, many of their largest customers themselves have little interest in new technologies. Thus, by ‘play[ing] the game the way it is supposed to be played’, industry incumbents ironically become vulnerable to challengers.
Like many large industrial companies, Germany is bound to restructure its maturing activities whilst developing deeper competencies in high technology, in particular in electronics and software. Ideally this would be done as part of an EU-wide industry policy. However, the current framework is deemed to be unsurprisingly incomplete, fuzzy and inconsistent. I believe the solution includes EU-wide industry consolidation. As a matter of fact, research demonstrates that market concentration has stayed flat in Europe over a decade or so, whilst it has continued to increase in the U.S. Some catching up would allow leading companies to set the industry policy agenda through enhanced scale, relevance and pan-European status, thereby improving their ability to compete against the rest of the world for a more competitive environment globally.
Whilst countries such as the U.S., China and the UK are putting more emphasis on economic sovereignty, the European Union is bound to seek ways to transcend its national boundaries. As far as Germany is concerned, its challenges are daunting but thankfully its assets are formidable. It may not master the latest tech, but it owns deep domain expertise across all industrial markets. Its fiscal fire power is exceptional. It also possesses strong European credentials, with a population firmly behind the European Union. All of this puts the country in great position to actively contribute to the consolidation of the European industry.