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A miracle that masks a mirage

Published in The Australian (Sydney), 1 September 2011

The announced job losses at BlueScope’s steel plants are just the latest episode in the long decline of Australia’s non-resource industries. The trend towards deindustrialisation is much older than that.

It was fostered but not started by the rise of the Australian dollar. Manufacturing in Australia is squeezed between a booming primary sector on the one hand and a drive towards services on the other.

It is not just nostalgia about the days of smoking factory chimneys that worries some commentators. People such as Paddy Crumlin, secretary of the Maritime Union of Australia, argue a strong manufacturing sector is essential to keep an economy robust. In an interview on the Ten Network’s Bolt Report, Crumlin singled out Germany as an example. “You have to keep a manufacturing base,” he said. “Look at Germany. Where would Europe be without Germany and without Germany’s manufacturing base?”

Though Crumlin is certainly right that Germany’s recent economic performance has been driven by its strong industrial sector, we should not jump to the conclusion that the German model could or should be copied.

Economic structures do not form overnight. They are the result of decades, even centuries, of economic activity, policy and resource endowments. They reflect legal, cultural and geographic circumstances. In this sense, they are unique to each country. It is a historical notion to transfer one country’s economic model to another.

There are enormous differences between a small, densely populated and resource-poor country in the middle of Europe, and Australia, which is in every respect the precise opposite. For this reason alone, it is very unlikely that Australia could ever have a German-style manufacturing sector.

However, on closer inspection, the German manufacturing miracle may not even turn out to be as splendid as it first appears. There are some aspects of Germany’s industrial strength that are certainly not worth emulating elsewhere.

Germany has positioned itself as an economy that produces highly sophisticated goods to which a lot of value is added. For any developed, high-cost economy this is the only way to remain a manufacturing country. The cheaper end of the market, which is the mass production of low-tech goods, is much more cheaply served by economies with a lower wage level. Consequently, industries such as textiles have moved to eastern Europe and Asia.

What reinforced this shift was Germany’s tightly regulated labour market. Labour is not only costly in Germany. It is also immensely difficult under German law to fire workers. According to the Fraser Institute’s latest economic freedom report, there is less freedom in Germany’s labour market than in countries such as Zimbabwe, Iran and Syria.

German manufacturers have reacted to complex labour market regulation and high labour costs by substituting capital for labour wherever possible. This has contributed to Germany’s drive towards highly sophisticated manufacturing.

The flipside of this development is high unemployment, both open and hidden. This particularly affects the least productive workers for whom there are barely any jobs left in hi-tech Germany.

In recent years, German manufacturers have received another boost through Germany’s membership of the eurozone. The crisis in peripheral countries such as Greece has not only led the European Central Bank to a very loose monetary policy. It has also weakened the euro’s exchange rate. Germany has benefited from both developments.

Put simply, if Germany had kept its own currency, the deutschmark would have appreciated in the boom of 2010-11 and the Bundesbank would have tightened monetary policy. Instead, German companies were enjoying cheap interest rates when their exports were super-competitive in international markets thanks to the weak euro. No wonder companies such as Mercedes-Benz are celebrating record sales in China and India.

Membership of the euro has the same effect on Germany as pegging the renminbi to the US dollar has on China. It supercharges exports and amounts to little else but neo-mercantilism. This is not to say that Germany does not produce highly attractive products; of course it does. But without an exchange rate reflecting the Greek, Italian and Portuguese crises, Germany would have never been able to export as much as it does.

This also explains why the German government is keen to keep the euro currency alive. The moment the euro collapses, the ensuing appreciation of Germany’s exchange rate would ruin the competitive advantage on which Germany’s manufacturers have happily relied for years. The bailout packages for the euro periphery are the price the Germans have to pay for this essentially unfair trade advantage.

Germany’s strong focus on an export-oriented manufacturing sector has also left the economy unbalanced. Exports account for nearly half of Germany’s gross domestic product. Consequently, Germany is vulnerable to global economic trends. Thus a severe contraction of 4.7 per cent of GDP in 2009 was followed by an impressive growth figure of 3.6 percent in GDP.

So the German economy is at least as heavily tilted towards manufacturing as Australia is exposed to changes in commodity prices.

As it turns out, there is not much in the German manufacturing example that Australia should copy. We would be much better advised to make the best of our own comparative advantages of being a resource-rich economy in close proximity to the fastest growing part of the world economy.

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