Germany and the Future of Europe

YPO PRESIDENTS PROGRAM 2016

Instructor Prepared By:

Rawi Abdelal Julian Montejo

In spring of 2015, Germany’s chancellor Angela Merkel had logged significant

successes. Germany was one of the largest exporters in the world, had maintained low
unemployment through the 2008 financial crisis, and was gradually reforming its
welfare state to meet future pension liabilities. Yet it still faced considerable
challenges. Within Europe, the Eurozone financial crisis continued to hold down
economic growth, and the burden of leadership to find a solution seemed to fall on
Merkel’s shoulders. Beyond the bounds of the European Union, Russian interventions in
Ukraine worried European leaders, who both wished to punish the Putin regime but
also relied heavily on Russia for energy. Could Germany sustain its recent economic
success, while also saving Europe?

About Germany and its economic development

The Origin year 1834 to the end of world war I in 1918: Germany set the goal
to become the land of big industry, big banks, big agriculture and big government.

It was with all variety of tools at hand the Germany formed its wealth and strength:

1. A huge tariff wall against industrial and agricultural products

2. Industry cartels officially backed by the government
3. “Financial Capitalism” a system were banks wer expected even forced to
provide capital generally in exchange for stock.
4. Double board system of corporate governance: the management board in
charge of day to day operations and the supervisory board were other
interested parties like banks and unions were invited to deal with major
strategic desitions.

By the end of world war I Germany was already stronger than Great Britain in
industrial production. However the penalty of loosing the war, 132 billion gold marks,
was a huge threat to the economy. Ultimately Germany paid only 20 Billion.

Crisis from the end of world war I forward was challenged by big German firms with
even a stronger cartelization were all sorts of joint ventures emerged among
competitors in order to improve cost efficiency and productivity to export to Europe.
This prepared Germany to enter World War II from which in turn came out defeated.
After World war II the Germans continued applying the same economic model only
this time with more resolution.

1. The Government wanted labor unions to take on a protagonist role on firm

management and provided workers with a lot of financial support.
2. Banks continued to provide extensive capital, owned large shares on companies
and sat on supervisory boards.
3. Small and medium size companies received great attention from other financial
institutions.
4. Worker participation was very well organized by sector unions which ultimately
gave a strong commitment and few stops on labor days.
5. Training was broad based to allow mobility of workers from one job to another.
6. The central bank was a strong balancing player of this whole model, making
interventions decisively when necessary.

The result: Average growth GDP of 6% during the 50s and 60s,
unemployment below 1%, exports grew from 8% OF GDP in 1950 to 24% in
1974.

A new crisis came in 1979 and lasted almost 20 years which included the
reunification of Germany starting in 1989. The financial challenges were huge and the
sustainability of the whole welfare system had to be financed with bigger contributions
and less benefits which was detrimental to employment. The globalization brought
major competition for German exports from eastern European countries, Chinaa and
Latin America.

The recipe to face these new crisis was:

1. Labor concessions on wage limits, flexible working hours, reorganization of

production.
2. Attack to the bank ownership model and creation of open stock exchange to
bring capital markets attention.
3. Creation of “Minijobs” a special type of employment with much lower
contributions.
4. To create jobs they created a whole new renewable energy sector which
received huge subsidies from the household consumers but allowed Germany to
provide electricity at a more competitive cost to industrial firms.

From 2000 to 2008, Germany:

1. Recorded a cumulative net surplus of 1400 million euros coming from increased
exports.
2. Productivity grew by 3.2% per year
3. Banks got overexposed by making huge loans to german companies to fuel
exports, but by 2009 the credit was 704 Billion Euros to Greece, Ireland, Italy,
portugal and spain.

The Eurozone Crisis was faced by the EU and Germany with the following
measures:
 1. The bailout loans backed by all UE member and the IMF, helped rescue Greece
and also some German Banks.
2. European stabilization mechanism to issue debt to EU member states in need.
3. Fiscal Pact to reduce budget deficits below 3%.
4. Germany also bought shares in some banks
5. Allowed companies to agree on working time accounts with the unions to permit
them to pay less if demand was low. Government will top up the salary which
was better than to pay unemployment insurance.
6. Direct Fiscal stimulus for firms, banks and consumers to push up demand.

Still the Eurozone crisis remains and the threats are:

1. Greece is still unstable.

2. Russia’s crisis with Ukraine presented a potential disruption on gas supplky to
Germany which used it for almost 30% of its energy needs.
3. Financial market yields are close to zero.
4. Germany’s current account surplus would be 8.5% of GDP

Assignment Questions

1. What is the source of Germany’s export success?

1.1. Unified currency with many countries that are behind on the construction
of their industrial sector.
1.2. Financial backing for exports by private and public banks.
1.3. Industry cartelization to keep prices under control and avoid competition
among german firms.
1.4. Strong employee participation to keep productivity levels to its optimal
point.
1.5. Tradition and maturity of its industrial and agricultural companies in
comparison with many other eastern European countries with no
production capacity at all.
1.6. Disciplined and structured governance system.
1.7. Logistics and infrastructure.
1.8. Control on cost of utilities.
2. Evaluate Germany’s response to the Eurozone:

Germany protected its banks which in turn protected the firms that contribute the most
to German solid economy. The exporters.

In my opinion Germany did good and shall continue to support the EU since it depends
largely on them to maintain its internal indicators well. A healthier UE means a
Healthier Germany

Also Germany has to pursue diversification both on the demand and on the supply side
of its commercial trading position with EU members. Specially try to find alternative
sources of energy than Russia and different customers than the EU countries. Maybe
focus on the US and Canadian markets or emerging markets such as Latin America.