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Global Economics

The Paradox of Resurgent German Industry

Common wisdom says the future belongs to the service industry, but manufacturing is currently the engine of growth in Munich and beyond

These days Michael Walter, 43, often finds himself committing what would normally be considered sacrilege in the business world: He's turning customers away before they can even place an order with him.

"I simply have to tell them that I won't be able to help them until later, says Walter, the CEO of Gutehoffnungshütte Radsatz in the western German city of Oberhausen, a company specializing in the production of wheels and axles for rail vehicles.

Orders have been piling up like the wheels in the company's more than 90-year-old factory building in Oberhausen's Sterkrade district, where employees work in three shifts to produce wheels and axles for customers around the world.

The company's sales have risen by 60 percent within the last two years. Even though Walter has increased the work force by more than 25 percent and created 50 new jobs, the order backlog has barely declined. "And this won't change in the next year and a half," he says.

Gutehoffnungshütte Radsatz isn't the only German company where business is booming. The story is much the same at Bauer AG, a manufacturer of specialty construction machinery located in Schrobenhausen, a town near Munich, where CEO Thomas Bauer is confident about the future and pleased with the past. Last year Bauer added 200 new employees throughout Germany, and this year he plans to hire another 100. "The machine building business is going extremely well," he says.

"The Best Period We Have Ever Experienced"

The recovery has even buoyed industries in eastern Germany, a region chronically plagued by job loss. "This is the best period we have ever experienced," says Klaas Hübner, the owner of a mid-sized group of companies in the machine building business in Neugattersleben, a town in the former East German state of Saxony-Anhalt. "We will increase our work force by 10 percent this year," says Hübner, who is also a member of the German parliament, the Bundestag, representing the center-left Social Democratic Party (SPD).

From Neugattersleben to Schrobenhausen to Oberhausen -- throughout Germany, for that matter -- manufacturing companies are reporting record orders, production growth and hiring levels. For decades, the gradual shift from a manufacturing to a service-based economy seemed inevitable. It was seen as virtually a law of nature that manufacturing's share of the economy must shrink while the service economy grows. It was said that Germany no longer had a future as a manufacturing country, and that jobs represented its last export product.

But reality has refuted the theories, while Germany's economy continues to grow. Virtually all production indicators are pointing upward. The manufacturing sector is expected to grow by four percent this year, a rate more than twice as fast the economy as a whole.

For years, gross value added has grown faster in manufacturing than in the service sector. More importantly, the Association of German Chambers of Industry and Commerce (DIHK) estimates that industrial companies will be responsible for 100,000 of the anticipated 300,000 new jobs that will be created in Germany this year.

"Right now we are experiencing a renaissance in German industry," says Volker Treier, the chief economist at the DIHK.

The dynamics are impressive. Even though industry, not including the construction sector, provides only about 14 percent of all existing jobs, it is responsible for one-third of all new jobs -- two-thirds if one includes the jobs created by service companies affiliated with industry. These businesses, like software companies and billing services, are also expected to add 100,000 new jobs this year.

Part 2: Growth Through 2010 and Beyond?

This development is by no means self-evident. In the last boom, in 1999 and 2000, manufacturing companies laid off large numbers of workers, even though the economy grew by more than three percent. After shrinking rapidly, manufacturing has begun to gain ground once again. Its share of annual economic output has declined from 40 percent in 1970 to less than a quarter today, but that number has begun to increase again recently.

According to a forecast prepared for the German Economics Ministry, this trend is expected to continue until at least 2010. Manufacturing is expanding at an especially high rate in the former East German states, where it has grown twice as fast as in the West since 2003. Eastern Germany accounts for more than 11 percent of industrial production today.

Exports reflect the importance of manufacturing. Almost nine-tenths of all German exports are industrial products. This is not without consequences for the service sector. According to a position paper by the Economics Ministry, "industry provides the impulse for growth in the service sector." Forty percent of all services, as well as 63 percent of all research and development activities and engineering services are provided for industrial companies.

"The strength of German companies in world markets is based on the fact that they offer a package of their products and services that go along with the products," says Hans-Joachim Hass, director of the economic policy division of the Federation of German Industries (BDI). For instance, a German machine tool manufacturer that supplies a production line to a customer in the United States may operate it using personnel from its own service company until local workers have been trained.

Bernd Pfaffenbach, a senior Economics Ministry official, has identified another secret of the success of German industrial companies. "The cooperation and distribution of labor in large and small companies is unique; it's something that doesn't exist anywhere else in the world," he says.

Germany has far more industrial competency and substance than Great Britain, for example. Unlike the British, the Germans do not treat industry as an economic structure that is essentially a holdover from the 19th century, nor do they see the service sector as the only possible saving grace for the country's future. "We have consistently focused on an industrial core, and now it's paying off," says Pfaffenbach. "We cannot survive by cutting each other's hair."

On the other hand, Germany benefits from the industrial diversity it has managed to preserve. China and India, which represent large parts of the world, are becoming industrialized, and German companies can offer precisely the range of products that emerging economies need to continue industrializing, from machine tools to entire steel mills to the cars that the rising middle class in these countries will want to start buying soon.

Rising Exports

This demand is reflected in the increase in the share of German industrial production designated for export, from 28.3 percent in 1994 to 42.3 percent in 2006. The machine building, chemical and automobile industries export well over half of their entire production.

In addition, German companies have been extremely proficient at adapting to the needs of globalization. They have become specialized, and in many cases they are now the global market leaders in their niches. Gutehoffnungshütte Radsatz, for example, is the world's leading manufacturer of low floor trams. Wheels made in Oberhausen roll in Perth, Hiroshima and Vancouver. The main reason behind this traditional company's success is that it kept reinventing the wheel. One of its specialties is a wheel that can be steered individually, which allows streetcars to navigate through even the narrowest of streets. The technically sophisticated design of the wheel calls for 400 individual parts. "This isn't something just anyone can do," says CEO Walter, one of the company's owners.

Many manufacturing executives believe that the economic environment has also improved in Germany. "Unit labor costs didn't increase for years," says business owner Bauer. "This substantially increases our ability to compete against competitors from other countries." According to Bauer, the so-called Agenda 2010 economic and labor market reforms passed by the government of former Chancellor Gerhard Schröder are also a factor.

Bringing Jobs Back to Germany

These factors have helped make Germany become so attractive as a manufacturing location that many companies that had outsourced their production abroad are now coming back. "Wages are undoubtedly lower abroad, but outsourcing isn't all that easy after all," Bauer explains. In other countries, workers must be trained first, which sometimes creates problems when it comes to challenging activities. Bauer has discovered that manufacturing at home has its advantages over outsourcing abroad after all, advantages like the ready availability of materials or proximity to suppliers.

Notwithstanding these opinions, there are no reliable statistics on how many companies are bringing outsourced jobs back home to Germany, just as there are no reliable statistics on how many domestic jobs are lost to outsourcing. In any case, employees also benefit from the industry's successes. Steelworkers, for example, have seen pay increases of about four percent a year since 2005, while the metal industry experienced similar pay increases across the board last year. Employees in chemical companies have also done well.

Meanwhile, workers in the service industry must routinely make do with shrinking incomes. In many sectors, wages are now so low that the unions are demanding a legal minimum wage. With the exception of the chronically ailing construction industry, minimum wages are not an issue in any branch of manufacturing.

Minimum wages are also irrelevant for the CEO of Gutehoffnungshütte Radsatz. Walter pays all of his lathe operators, cutters and metalworkers wages above the standard rate. They even receive a share of the company's profits at the end of the year.

The company still has money left over, and last week it acquired its key competitor from France, doubling its size.

Translated from the German by Christopher Sultan

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