The Stalling Engines of German Economic Productivity
Carson Rayhill
The fall of the Berlin Wall in 1989 set the stage for Germany to join the ranks as an economic powerhouse. The capital-rich West German market opened itself to a labor-rich East German economy that had been weighed down by a lack of capital. The convergence of the two markets, combined with the help of the Marshall Plan, a U.S. given post-war relief stimulus, led to an economic boom dubbed the Wirtschaftswunder, or the economic miracle. While the German economy has grown by over 2.5 trillion dollars since the unification of the east and the west, total factor productivity (TFP) has been on the decline since well before the fall of the wall. TFP is generally a good indicator of the efficiency between connecting labor and capital in the economy. Therefore, innovation, technology, and economically liberal markets lead to a higher TFP, whereas inefficient markets and restrictive labor laws lower it. The alarming decline of German TFP has caught the eye of notable economists including Nobel laureate Edmund Phelps. In 2019, on the 30th anniversary of the fall of the wall, Phelps addressed his concerns that German economic policies have led to a decrease in innovation and an increase in regulations, which combined have yielded diminishing productivity in the economy.
Although Germany has a complex system of business regulations and rules to protect worker’s rights through the social market economy, Phelps focuses on one specific regulation: the German concept of Mitbestimmung or codetermination. Codetermination is a law requiring that corporations employing over 2,000 people fill 50% of the seats on their board with representatives of the workers in the company. Although it sounds like a novel concept, Germany has always had a long history of including workers in the hierarchy of business decisions. The guild systems introduced in the 12th century eventually gave way to modern forms of worker’s rights under the social market economy. The first codetermination laws, for instance, were written in 1976, well before the fall of the Berlin Wall. These practices led to trust between workers and their employers as well as a sense of control over business policies, historically making German workers more productive. In the modern economy, however, the downsides of such policies are seen to severely limit productivity and innovation within the German economy.
Although codetermination leads to more communication flows between the employer and their employees, Phelps proposes that it can also lead to hierarchical barriers for employees to pitch new ideas or processes to their employers. This indirect flow of communication and idea-sharing can often slow down the process of innovation in a company. In the modern economy, speed is of the essence. Technology has allowed companies to process information and create new products and services faster than ever before. Jeff Lerner, the CEO of the digital marketing company Xurli, says, “In a world where everything is moving so rapidly, simply being fast isn't enough; you have to be faster than anyone and everyone. Accelerate until you're at the front and move fast to stay there.” If Kodak would have reacted more quickly to the shift to digital media, for instance, one would suspect they would be more prominent than they are today. The same could be said for any company in the modern economy. Codetermination, alongside other German business regulations, can, ever so slightly, slow down the thought sharing process. In the past, these minor delays in innovation were not as significant as they are today. German companies may be left behind their competitors if they cannot find contemporary ways to balance worker’s representation in business and the need for innovative speed.
In addition to slower innovation processes, German regulations make it more difficult to lay off workers. “Supply and demand” is not a valid excuse for companies to fire employees in Germany. The law requires more direct reasons for employers to get rid of their employees. This means that the hiring process is extremely important. Human Capital is not as flexible to German companies, and if a firm wants to grow, they have to balance the number of people they hire, since they will not be able to use the market as a guide in changing that going forward. Such regulations make it difficult to start and rapidly grow a new business in Germany. This means that older and larger firms are already at an advantage when it comes to meeting new consumer trends, furthering the cycle of lower innovation and productivity that could be supplied by new small businesses in the economy. There is no doubt that Germany is a world economic powerhouse, but the effects of a highly regulated market are beginning to take their toll on the economy.
At the start of 2020, Germany had the highest nominal GDP of all countries in Europe. They were ranked seventh, however, in innovation compared to other European countries by the Global Innovation Index. Countries like the UK and Switzerland, although having smaller economies, are seeing higher rates of innovation. The index data shows that the majority of the innovation comes from the number of highly educated workers in the economy. Thus, it is no wonder that science and medicine companies lead the charge on innovation in Germany. The weaknesses cited by the index, however, include the “ease of starting a business” where they are globally ranked 96th, and the “cost of redundancy dismissal” where they rank 90th. In addition, studies by the University of Southern California in 2016 show that the German economy was only responsible for 2% of the world’s billion-dollar start-ups. The data shows that the negative effects of codetermination and other business regulations are slowing innovation in Germany. Although regulations within the market certainly play a role in inhibiting a lack of productivity, the convergence of the East and West German markets has led to disproportionate growth and may also account for a lack of productivity.
Even today, for instance, eastern Germany has a lower capital intensity than the western part of the country, and poorly developed infrastructure makes innovation and access to capital more difficult. Additionally, underemployment has historically been an issue for eastern Germany. When the eastern market opened, firms flooded manufacturing plants to the region to take advantage of lower costs, but most of the highly skilled jobs remained in the west. Because most of the capital, and therefore, most companies are settled there to this day, young Germans are forced to bring their talents to the west or risk the possibility of underemployment if they stay in the east. The continued disconnect between the two regions definitely plays a role in lowered total factor productivity.
Germany is facing a unique challenge when it comes to raising productivity. A fully converged market between the west and the east would help pave the way for a more productive economy. This will require investments in infrastructure and public capital in the east. Even within a fully converged market, however, Germany will continue to struggle unless they can prove to young entrepreneurs and to the world that they are open to growing small businesses. The challenge will be to find a balance between the government’s role in protecting workers’ rights and removing regulations that stifle innovation. Both of which are extremely important in our fast-paced, global economy. Innovation is one of the biggest drivers of the economy, and if Germany can’t bring it back to the driving seat, they might find themselves left behind on the shoulder of the economic autobahn.