Industrial Innovation
Germany's Crisis

Germany does face an 'innovation crisis', but the debate in Germany has focused on the wrong problem, David Audretsch told a Bonn lunchtime meeting on 29 March. There is no evidence of an innovation crisis in industries where Germany has traditionally held a comparative advantage. Instead, the problem lies in newly emerging industries such as computers, telecommunications, and biotechnology. The inability of German - and European - firms to innovate in these new industries is at the heart of the real innovation crisis. Audretsch is Research Professor at the Wissenschaftszentrum Berlin für Sozialforschung and a Research Fellow in CEPR's Industrial Organization programme. His talk was based on his CEPR Discussion Paper No. 1152, 'The Innovation, Unemployment and Competitiveness Challenge in Germany' . The meeting was organized with the Anglo-German Foundation for the Study of Industrial Society.

Germany's share of R&D activity has declined relative to Japan and the US. But the relative technological advantage of German companies in those industries in which the country has traditionally had comparative advantages (chemicals, specialized machine tools, and automobiles) has not deteriorated significantly over the past decade. These companies have experienced a healthy recovery in their profitability and share of world export markets as Germany has emerged from recession. Germany's traditional industries do not suffer from too little innovation: according to Audretsch, their real problems lie elsewhere, in the _Standortkrise' or location crisis. Germany has become vulnerable because its high wages and other costs of production give firms an incentive to shift production to lower cost locations. The relatively standardized production processes of mature traditional industries can be easily replicated in other countries, and the continued transfer of production facilities, through foreign direct investment and corporate restructuring, has left large numbers of displaced workers. Introducing new technology and redeploying the labour force more efficiently has also resulted in substantial productivity gains and job losses elsewhere in Europe. For example, 70 per cent of Sweden's manufacturing employees work for large companies, most of them multinationals such as Volvo, which have been steadily shifting production out of Sweden to lower cost sites. In Germany, every third car manufactured by a Germany company is actually produced outside of the country.

How should Germany respond? Audretsch drew attention to the US innovation crisis of the 1970s which encouraged a shift of economic activity out of mature industries and into newly emerging sectors. Employment growth and levels never recovered in industries such as steel, automobiles and rubber, and between 1980-93, the 500 largest US manufacturing corporations eliminated 4.7 million jobs, one quarter of their work force. Similar downsizing has taken place in Germany: in 1994, for example, employment fell 4.7 per cent in the profitable and still growing chemical industry. Can these displaced workers, as well as new entrants, be absorbed into productive activity in the same location? Only if, Audretsch argued, economic activity is shifted out of traditional sectors and into newly emerging industries. The US had managed to do this successfully and US unemployment has continued to decline and employment has grown. Since 1972, the US has created 35 million jobs, mainly in the private sector. By contrast, over the same period, Europe has created only 11 million jobs, over half within the public sector. The result has been persistently high unemployment in Europe.

The shift to new industries can be difficult. Audretsch noted recent research in organization theory and business history, which reveals that whether a firm adopts a new technology depends on whether the technology falls within its 'core competence'. The cost of adopting new technologies is much lower for 'competence enhancing' innovations than for 'competence destroying' innovations. This is apparently true not only for individual firms, but also for nations as a whole. Recent research which analyses patenting patterns over a wide range of countries shows that even over long time periods, the technological capabilities of most countries remain remarkably specialized. Most tend to specialize in just a few industries, and within those industries, new technological developments tend to diffuse fairly rapidly. This suggests that attempts by Germany to broaden its technological base are likely to prove difficult and costly.

Audretsch also noted recent developments in economic geography which highlight the importance of location and proximity in exploiting knowledge spillovers. As a result, a technological lead, once lost, may prove difficult to regain since the early leaders in a sector may acquire a decisive advantage because of agglomeration. This may help to explain not only why German high-technology firms tend to move their headquarters to selected locations in North America, but also why many entrepreneurs elect to start their new firms there in the first place. Nearly 20 per cent of Europe's top 50 software companies have moved their corporate headquarters to America, and European drug companies are heavily engaged in joint ventures with or purchases of American biotechnology companies in order to gain access to new technologies.

Germany will not find it easy to make this transition, according to Audretsch. Many of the factors that made Germany so successful in its traditional industries will make it extremely difficult to shift into new sectors. For example, the German banking and financial system is given much of the credit for Germany's post-war economic success. By allowing bank ownership of private companies, the system allows companies to avoid liquidity constraints experienced by foreign competitors. But this virtue may now have become a vice: it is mainly the large incumbent companies (typically in traditional industries) that receive a generous flow of cash from German banks. What has been overlooked are entrepreneurs with different ideas, who may experience severe difficulties in raising finance. For example, there have been only negligible venture capital and informal capital markets developed to channel finance into projects involving new technologies and industries. The German tax and legal systems form another institutional barrier, tending to discourage innovation and entrepreneurship. Tax laws, for example, force new companies to pay out dividends from earnings almost as soon as they appear, hence discouraging their reinvestment. In addition, German bankruptcy laws act to discourage innovators: after two bankruptcies the entrepreneur can legally act only as an employee.