From quality competition to wage dumping

"Today, real technological progress is mainly taking place in the USA and China. The export-based German economy, on the other hand, has so far only managed to keep its head above water thanks to wage moderation and low taxation. In the short term (and in intra-European competition) this price competition based on wage dumping may still work, but in the long term (and globally) it will hardly work,' writes the great German intellectual Andreas Nölke, who in Makroskop offers a very interesting rereflection on the main disease that has afflicted the German economy for at least two decades, namely exportism, i.e. the deep dependence on exports. Andreas Nölke from Makroskop.de

Those who defend Germany's trade surpluses often argue that it is not our fault that the world is so interested in our wonderful products. The world loves German cars and machines.

Now this might even be true in some cases, if we look at our exports in the area of top mechanical engineering or luxury cars. But if you take a more systematic look at the development of German exports, you will see that an increasing proportion of these exports are sold essentially because they are 'cheap'.

In principle, the purchase of a product is always about both aspects: quality and price. In the case of German exports, however, there is a rather problematic shift towards the second aspect. A large number of empirical studies are already available on this topic.

From quality competition to dumping

Over the past five decades, the German economy has developed from an export-intensive but relatively balanced economy into an extremely export-dependent economy. It is striking that the 'pathological' intensification of German export orientation has not been accompanied by major technological innovations, but increasingly by a drive towards price competition. Export success, however, should not be seen as a sign of industrial strength, but of weakness - even if this weakness is only that of our European neighbours ('too expensive').

Arndt Sorge and Wolfgang Streeck, for example, referring to their concept of "diversified quality production", typical of German industry, note that this in terms of fundamental characteristics is still partly intact, such as product differentiation, although it is now fundamentally no longer based on the "beneficial constraints" of high wages and the innovations that go with them, but is increasingly based on cost advantages.

After an initial slump around 1980, since the mid-1990s the German industry has interrupted its long-term trend of upgrading to higher quality, and has since then increasingly relied on price advantages. Lucio Baccaro has quantitatively mapped this development by calculating the relationship between export and import prices. At the latest since 1995, this ratio - as an indicator of upgrading - has not increased, in stark contrast to the development observed in previous decades. The argument that German exports have become more price competitive since the mid-1990s is also confirmed by the Bundesbank, irrespective of the indicators chosen.

The relevance of export prices becomes particularly clear when comparing with Italy, a traditionally very competitive competitor in key sectors of German exports, among them car and machinery production. In the meantime, however, Germany has clearly outperformed Italy in terms of export performance, although, according to a study by the International Monetary Fund, about half of this success is attributable to an increase in German productivity - partly due to wage moderation in Germany.

The OECD reports that, especially in the first decade of the millennium, there has been a clear tendency for the German economy to achieve its export successes no longer through the quality of its products, but increasingly through price restraint, in contrast to earlier phases in which it was mainly innovations - measured, for example, by the number of patent applications - that ensured such successes.

A detailed analysis of 'international trade in research-intensive goods' also shows that Germany's comparative advantages remain predominantly and relatively stable in 'high-value technologies' (motor vehicles, mechanical engineering), but not in current 'cutting-edge technologies', with some exceptions in medical technology, measurement and control. China, on the other hand, has significantly expanded its market shares in both segments, especially in cutting-edge technologies.

And even in high-end automotive technology and components, export success is increasingly based on price competition rather than quality competition, according to this study. After all, Germany does not only produce luxury vehicles for which - as status symbols - price is of relatively little importance. Baccaro and Benassi come to similar conclusions, measuring an increased price sensitivity of German exports in the automotive and mechanical engineering sectors in the years since 1990, in contrast to previous decades.

These findings are further confirmed by a recent study by Sebastian Dullien, Heike Joebges and Gabriel Palazzo. The study highlights the importance of price competitiveness for German exports, including exports of 'high-tech' goods. This cost competitiveness was significantly improved in the early 1980s on the one hand and later on between 1995 and 2012, i.e. after the 2 major crises of the German economy.

The end of the stalemate

These observations, however, do not bode well for the long-term development of the German economy. For some time now, the German economy has ceased to be at the cutting edge of technological progress, for example in biotechnology or the digital economy. It is innovative in some areas, but only in the incremental development of technological innovations whose basic features are already decades old, especially in chemistry, mechanical engineering and the automobile industry, which is based on combustion engines.

Today, real technological progress is mainly taking place in the USA and China. The export-led German economy, on the other hand, has so far only managed to keep its head above water thanks to wage moderation and a low tax burden. In the short term (and in intra-European competition) this price competition based on wage dumping may still work, but in the long term (and globally) it will hardly work.

In other words: having saved jobs through wage moderation and austerity in recent economic crises may have helped to stabilise this model. In the meantime, however, this strategy seems to have come to an end.

In the long run, an economy with high labour costs, such as Germany's, can only survive if much more is invested in research, technology and the skills of the workforce - and if economic growth and jobs depend not only on uncertain developments in foreign export markets, but also, in a complementary way, on stable domestic demand.

In this context, it would be a very big mistake to react to the 2021 recession caused by the Coronavirus by continuing to push the export model based on cost compression, e.g. through austerity and collective wage moderation. This would only further intensify an already pronounced inequality.

For exports to play a crucial role, but within a more balanced economic structure, it would be helpful if these exports were made through quality products and not just through competition based on ever lower prices. The latter is incompatible with the necessary stimulation of domestic demand through wage increases and public spending. Even in the long run, you cannot win against low-wage countries.

The higher quality of products - or their higher positioning as status objects - would on the other hand also allow higher prices to be extracted and would thus be compatible with the need to raise wages and thus rebalance the German economy. There is also a need for more investment in research and development by companies, which in turn will serve to increase domestic demand. Higher wages thus act as "beneficial constraints" (Wolfgang Streeck), and force companies to do their good, i.e. to make investments.

In Germany, the conditions for high-quality, high-price exports are still in place.

Turning the economy around with a high-wage strategy is not feasible with every export structure. When wages and prices rise, countries with a price-elastic export structure, such as those linked to basic textiles, are faced with a sharp drop in their exports, as buyers can easily switch to other suppliers.

It is also not so easy for a country to move from simple goods to more advanced goods and higher levels of technology. There are also considerable obstacles, which in particular in the long run may hinder a recovery of the southern European economies, as Jakob Kapeller, Claudius Gräbner and Philipp Heimberger show. The German economy, on the other hand, still occupies a leading position in an internal EU comparison with regard to the concept of 'economic complexity', an important indicator of a country's technological capacity, a concept developed by a group of researchers at Harvard University.

Germany still has a relatively good basis for successfully rebalancing its economy in a European comparison. Admittedly, we have seen that the share of price-elastic German exports has increased in recent decades - a very problematic development. But if we compare Germany's relative position with that of the other classic industrialised countries both within the EU (France, Italy, Spain) and outside (UK, Japan, USA), we will see that Germany maintains a relatively higher share of its exports in sophisticated and less price-sensitive goods than these countries, according to a study carried out by the Lower Saxony Economic Research Institute.

For Germany - like the blind man among the blind, so to speak - in international comparison, it should be even easier to maintain a high level of exports even in the face of reduced price competitiveness due to higher wages, unlike in Italy, for example, where in recent decades there have been considerable losses in market share caused by more price-sensitive goods, such as textiles and furniture, as a result of the rise of China.

According to the International Monetary Fund data cited above, there is no other country in the world whose profile of exported goods in recent decades has resembled that of China more than Italy. Italy has thus been the country that has suffered most from the 'Chinese economic miracle' in recent decades.

The same fate could also befall Germany in the near future - given the 'improvement' in China's export portfolio. It is still not too late to try to defend the competitive advantage through greater investment in research, development and the training of highly qualified and well-paid workers.

But this rebalancing will be a painful adjustment for significant parts of German industry. This is particularly true for those companies that have invested less and less in innovation and productivity in recent decades and have instead increasingly relied on wage moderation and an undervalued currency. In many cases, without the active support of the state, this will not be possible, especially in the area of technological development policy.