European Affairs

Summer 2000

 

Germany, Along with Europe, Is Embracing the New Economy
by David B. Audretsch

The new economy is coming to Europe, even if Europeans have had to go through a series of contortions to get ready for it. The European stance toward the new economy has evolved through five distinct stages, of which the first was denial. During the 1980s and early 1990s, many Europeans looked to Silicon Valley, where the new economy made its first appearance, with skepticism and doubts.

Europe was used to looking across the Atlantic and facing a competitive threat from large multinational corporations, such as General Motors, U.S. Steel and IBM, not nameless and unrecognizable startup firms in exotic industries such as software and biotechnology. The Cecchini Report to the European Commission in 1988 documented the economic gains to be achieved from further European integration in terms of traditional economies of scale.

Emerging American companies such as Apple Computer and Intel seemed interesting but of little relevance to the mainstay automobile, textile, machinery and chemical industries, which were the obvious engines of European competitiveness, growth and employment. The high performance of Silicon Valley was generally regarded as suffering from a short-term perspective, which sacrificed long-term investments and commitments for short-term profits.

The second stage, during the mid-1990s, was recognition. Europe recognized that Silicon Valley did, in fact, deliver a sustainable long-run performance. The theory of comparative advantage was sometimes evoked during this phase: Europe would provide the automobiles, textiles and machine tools, while the new economy of Silicon Valley, Route 128 and the Research Triangle would produce the software and microprocessors.

Each continent would specialize in its comparative advantage and then trade with each other. Thus, Europe held to its traditional institutions and policies, which channeled resources into traditional moderate technology industries.

The third stage, during the second half of the 1990s, was envy. As European unemployment soared into double digits and growth stagnated, the capacity of the American new economy to generate both jobs and higher wages became the object of envy. The United States and Europe appeared to be on divergent trajectories. As the new economy spread across the United States, it seemed that European traditions and values were simply inconsistent and incompatible with the new economy.

The fourth stage, during the final years of the 1990s, was consensus. European policy-makers reached a consensus not only that the new economy was superior to the old economy, but that Europe should have its own version. Leaders like Tony Blair in Britain and Gerhard Schroeder in Germany defied the politics and policies of their traditional left-oriented parties in advocating privatization and deregulation and encouraging entrepreneurship.

Rather than despairing that the United States had what Europe could not attain, a broad set of policies was instituted to create a European new economy. These European policy-makers looked across the Atlantic and realized that if places such as North Carolina, Austin and Salt Lake City could implement targeted policies to create the new economy, so could cities such as Munich and the Randstad (the urban agglomeration that stretches from Rotterdam to Amsterdam).

After all, Europe had a number of advantages and traditions that some emerging new economy regions in the United States did not, such as a highly educated and skilled labor force and world-class research institutions. In addition, Europe had a long tradition of government-industry-worker partnerships that, when redirected, could be well suited for the knowledge-based new economy.

The fifth stage will be attainment. While Europe may not be there quite yet, there are definite signs that a new economy is emerging on the old continent. One of Germany's most serious weekly magazines, Der Spiegel, recently ran a cover story explaining how the Old Continent was attacking U.S. economic power.

Britain, with its strength in financial and other services, and its emerging high technology centers, is the European country farthest along the road to the new economy. British and American venture capital is pouring into high-tech growth poles, such as the so-called "Silicon Fen" around Cambridge.

But Germany is perhaps the best example of how an old-style "metal-bashing" European economy is being dragged into the 21st century. One of the constant criticisms of Germany in the past has been its lack of venture capital. But German venture capital tripled in the 1990s, from € 1.6 billion in 1990 to € 5.4 billion in 1998. Listings on the German New Market increased from nine in July 1997, to 144 in July 1999, while capital volume rose from € 2.5 billion to € 55 billion. Still, the share of information and communications technologies in German GDP in 1998 was only 58 percent of the U.S. level.

What has triggered this rapid evolution of European policy toward the new economy? For many years, Germany's postwar social market economy generated a high standard of living that seemed to combine American wealth with lavish European social services and security. The so-called German economic model showed that capitalism could not only produce a high and equitable standard of living, but that it could have a friendly face as well.

The model was based on a consensus involving three principal actors - industry employer associations, labor unions and government. Through a broad spectrum of institutions, such as the Work Councils, industry-wide wage agreements and the apprentice system, these actors provided the basis for unparalleled success in generating high wages and levels of employment.

Under this consensus, labor fulfilled its obligations under the social contract by supplying the world's most skilled and disciplined workers. The employers' associations, grouping the leading German industrial companies, provided secure and well-paid jobs, together with a rich array of social services. Industries such as automobiles and metalworking were the most competitive in the world.

The task of the major political parties was to shift the fruits of this enviably productive consensus either more toward labor (the Social Democratic Party), or toward the established companies that comprised the employers' associations (the Christian Democratic Union).

The fall of the Berlin Wall accelerated the process of globalization by enabling countries that had previously been excluded to participate in the world economy. Combined with the telecommunications revolution, this development has shattered the social contract at the heart of the European social market economies. Pressed to maintain competitiveness in traditional industries, where economic activity can easily be transferred to lower-cost countries, the largest and most prominent European companies deployed two strategic responses. The first was to offset higher wages at home by increasing productivity through the substitution of technology and capital for labor. The second was to locate new plants and operations outside Europe.

What both strategic responses have in common is that the European flagship companies have been shedding jobs in their home countries. Between the mid-1980s and the mid-1990s, for example, Siemens increased employment outside Germany by 50 percent, while reducing its German workforce by 12 percent. Volkswagen increased employment in foreign countries by 24 percent, and cut jobs in Germany by 10 percent, over roughly the same period. Hoechst and BASF did much the same.

These examples are typical of the wave of downsizing in Germany in the 1990s that resulted in levels of unemployment not seen since World War II. The reaction of the German public has been to accuse German companies of not fulfilling the social contract. As one leading newspaper, Die Zeit, asked German industry in a recent headline, "When Profits Lead to Ruin - More Profits and More Unemployment: Where is the Social Responsibility of the Firms?"

During the early 1990s a number of case studies suggested that German entrepreneurs were faced with barriers to innovation. For example, a Bavarian software company, FAST, needed more capital to fund product development. But after being continually refused by financial and non-financial institutions, the founder, Matthias Zahn, made an Initial Public Offering on the NASDAQ and moved the company's headquarters from Bavaria to Redwood City, California.

This was no isolated example. Scores of entrepreneurs in newly emerging industries, ranging from computer software and hardware to biotechnology and visual reality, left the country in order to exploit their technological knowledge to the fullest.

Labor market institutions also impeded the arrival of the new economy in Europe. SPEA Software, a new startup company developing multimedia equipment near Munich, ran into opposition from German unions because its 130 employees were not unionized, and it did not belong to an employers' association. It was, thus, not part of the centralized system of labor relations to which most of German industry belongs.

Similarly, tax laws force the chief executive officers of new companies to start paying out dividends from earnings almost as soon as they appear, preempting high reinvestment policies. And bankruptcy laws in Germany have long stigmatized business failures as socially unproductive. It is virtually impossible to fail more than once and start again.

The collapse of such a successful economic model sent shock waves through Germany and beyond. Early in 1998, unemployment reached nearly 13 percent, with 4.7 million jobless, the highest level since the pre-Nazi Weimar Republic. There is no doubt that these persistent record levels of unemployment led to the demise of Chancellor Helmut Kohl and the CDU, which had ruled Germany for nearly 18 years.

It is the new European leadership that has brought the Old World to the threshold of the fifth stage, attainment. One of the most repeated phrases in the business news pages during the mid-1990s was a remark by Helmuth Guembel, research director of the Gartner Group in Munich, who said, "Put Bill Gates in Europe and it just wouldn't have worked out." A similar sentiment was expressed by Joschka Fischer, the current German Foreign Minister, who lamented in 1995: " A company like Microsoft would never have a chance in Germany."

But now there is ample evidence that Europe is indeed generating new economy entrepreneurs. Not only are software companies such as SAP rapidly gaining global market dominance, but the Swedish Internet firm, Framfab AB, founded by Jonas Birgersson, currently has over 2,000 employees throughout Europe. Mr. Schroeder has convinced Germans that, despite an unemployment rate of around 10 percent, there is an urgent need for a German Green Card, which would allow 20,000 foreign information technology and other knowledge workers to work in Germany for up to five years.

The widespread acceptance of the need for foreign knowledge workers reflects a profound change in Germany and in Europe. Only a few years ago, such a policy would have been unthinkable. This broad acceptance reflects a Europe that is well underway toward the new economy.

European attitudes are changing as the culture of the new economy takes root. Europeans have discovered the rewards of risk-taking, entrepreneurship and knowledge-based economic activity. Starting a new business is now in vogue, especially in the glamorous high technology sector.

It would be a mistake to think that the incipient European new economy will be a mirror image of its American counterpart. On both sides of the Atlantic, knowledge-based economic activity is generating growth and high-wage employment. In a number of European countries, social spending has been cut back and/or redirected. But Europe shows no signs of completely abandoning the cherished welfare states and social safety nets that are the cornerstone of its social cohesion.

Many American policy analysts have concluded that the freewheeling entrepreneurial values of the new economy are incompatible with the welfare state. Europe seems to be seeking to prove that it is not necessary to abandon all its social cohesion programs in order to embrace the new economy. Rather, Europe is on the verge of creating its own distinct new economy that builds on and takes advantage of its natural traditions and strengths.