Published in Business Spectator (Melbourne), 25 March 2010

http://www.businessspectator.com.au/bs.nsf/Article/The-flawed-giant-of-Europe-pd20100324-3U2PY

Worries about Australia’s productivity slump have long gripped politicians and commentators. The productivity surge of the 1990s is now just a distant memory. More recently, Australia experienced negative productivity growth, sparking a parliamentary inquiry. The latest Telstra Productivity Indicator showed how much Australia lagged countries like France and Germany in productivity growth between 2000 and 2008.

Although concerns over our own productivity are only natural, focusing on this measure alone is too narrow because it ignores labour costs and employment effects. A closer inspection of German productivity reveals that a nation’s high productivity can create an economy in which people find it hard to get their lawns mowed.

Germany’s productivity is as legendary as the ingenuity of its engineers. When the marketing executives at Audi AG realised they were being mistaken for an Italian car manufacturer, they were quick to use their domestic slogan Vorsprung durch Technik (advancement through technology) in international advertising campaigns.

The Audi catchphrase worked wonders in selling the company’s Germanness, but it describes more than just this single carmaker. It also sums up the business model of Germany Inc. No other country has based its economy on such a combination of high technology, extreme efficiency, and capital-intensive production. Unfortunately, this may have more to do with the country’s labour market and welfare state than with sophisticated German engineering.

The German language is productive indeed. It has forged a complicated word for this phenomenon: Entlassungsproduktivität – the productivity gains from lay-offs. Economists like Hans-Werner Sinn, president of the IFO research institute in Munich, have long argued that high labour costs are driving German companies to substitute capital for labour. This boosts labour productivity – and unemployment.

For many decades, German trade unions had successfully pushed for higher wages, particularly for low-income groups. Germany’s welfare state also contributed to increasing work costs. It is financed by payroll taxes, which means that employers have to pay roughly 25 percent in taxes on top of their gross wages bill. Add to that a well-developed – and costly – system of worker co-determination, whereby employees are involved in the management of a company, and it is not difficult to understand why German companies have been focusing their efforts on increasing efficiency and labour productivity. If it is costly and difficult to employ a worker, companies naturally start exploring other options – such as a new machine that could do the job just as well.

The German Federal Statistical Office provides good data to illustrate this. Between 1991 and 2009 capital intensity per worker, that is the private capital employed per job, rose substantially. In constant prices, it went up from €212,000 to €298,000 within this period – a cumulated increase of over 40 percent. This is not a new development, however. According to research by IWG Bonn, Germany’s capital intensity per hour worked has been higher than in any other industrialised country, except Japan, since the mid-1960s. This is even more remarkable considering the fact that working hours in Germany are among the lowest in OECD countries.

Although Germany’s productivity record may sound enviable, it has come at a huge price. It has triggered an enormous sectoral change and created a legacy of lasting unemployment. Jobs were cut in labour intensive industries where production was shifted to low-cost countries, mainly in Eastern Europe and Asia. Thus, in industries such as microchips, car components and textiles, Germany has lost employment thanks to a shift to increased capital intensity.

What this long process has brought about is an economy that is at the same time extremely productive and yet not very conducive to job creation. Workers lacking the qualifications necessary to be employed in high-productivity jobs are often relegated to a life on benefits. The jobless rate among them is much higher than in most other industrialised countries.

The situation would be more bearable if the service sector could make up for job losses in manufacturing. So far, this has not happened. It is for this reason that the new chief economist at Deutsche Bank, Thomas Mayer, recently shocked his fellow Germans in an interview with the Frankfurter Rundschau newspaper in which he suggested that the country should become not more but less productive. A great number of simple jobs had disappeared partly because labour costs were too high. The Germans, Mayer said, shied away from, for example, having their lawn mowed because such services cost too much thanks to high wages and payroll taxes.

For IFO economist Hans-Werner Sinn, Germany’s business model shows symptoms of a vicious cycle. It is built on a toxic mix of high labour costs, high productivity, and high savings. In pursuing ever-higher labour productivity, Germany exports machinery that will be used abroad by labour intensive industries – the same industries that Germany can no longer afford to have at home. Ironically, thanks to Germany’s high savings rate, it also able to provide the capital the other countries need to pay for these high-tech German imports. To Sinn, all this amounts to a ‘pathological export boom’.

Given this background, growing European uneasiness over Germany’s high trade surplus and lower unit costs appears in a slightly different light. France’s finance minister Christine Lagarde just told the Financial Times that Germany should increase wages to restore the competitiveness of its European neighbours. What she is actually asking for is a continuation of the very policies that brought Germany to its current situation of high productivity coupled with low domestic demand. Germany already has high wages and high total labour costs. Boosting them further will only reinforce the substitution of more capital for labour, but it will do nothing for countries like France, let alone Greece. A better option for these other countries would be to improve their own productivity.

Does Germany’s strange mix of Vorsprung durch Technik and Entlassungsproduktivität show that there can be too much of a good thing? Can a country become too productive for its own good? Probably not. But the German example clearly demonstrates that too narrow a focus on productivity can indeed be misleading.

Australians worried about their productivity performance in international rankings may relax a little. There is not much in the German experience that they should wish to copy.