Two of the most pressing problems of European economies are unemployment and deteriorating international competitiveness. In Discussion Paper No. 1152, Research Fellow David Audretsch takes the case of Germany to show how these problems are interrelated with a lack of innovative activity. Among the most cited sources of evidence for the existence of a German `innovation crisis' is the declining share of patent and R&D activity relative to the US and Japan. However, a closer look at the facts reveals that Germany has not lost significant ground in industries in which it has traditionally held comparative technological advantages. Rather, the challenge for Germany and other European countries seems to reside in newly emerging industries where European firms are insufficiently capable of innovating and participating.

High wages and other production costs in Germany (encapsulated in the term `location crisis') dictate that high cost production be constantly made more efficient or shifted into lower cost locations. Both processes result in large numbers of displaced workers who have to be absorbed by newly emerging industries. In order to reduce unemployment numbers, it is imperative for the German economy to strengthen its innovative potential. Hence, it is one of Audretsch's policy proposals to shift activity out of mature industries and into newly emerging industries. However, the specific institutional structure of Germany - where banks are allowed ownership of private companies - obstructs an easy flow of resources from one area to the other. Although it is true that this set-up helps to avoid corporate liquidity shortages, it also tends to favour large incumbent companies. Banks prefer to supply liquidity to `old' and `stable' firms rather than providing venture capital to outsiders, innovators and entrepreneurs. Moreover, companies tend to develop along technological trajectories determined by existing corporate competencies.

The Innovation, Unemployment and Competitiveness Challenge in Germany
David B Audretsch

Discussion Paper No. 1152, March 1995 (IO)