Germany Must Stand Up To China

Germany suffers from a reputation as a slow-growth country, but its machine-tool industry has shown amazing vitality. Orders for German tools soared 19% in 2004, an incredible achievement considering that the euro was at record highs. Thanks are due mainly to a new customer with a voracious appetite for manufacturing technology and a high regard for German engineering prowess: China, which accounted for 17% of foreign demand.

But the growth won't last, and German industry should not be too exultant about it. On the contrary, German CEOs and political leaders should already be thinking hard about how to counter the threat of growing Chinese competition in capital goods -- which are second only to cars as Germany's leading export. Failure to protect German dominance in capital goods would have grave consequences for the economy.

Fact is, China is feverishly building its own machinery industry, which is already supplying auto and textile factories and other major sectors of the Chinese economy. Chinese machinery companies are winning customers in Asia and are expected to make inroads in the U.S. Germany continues to dominate the market for the most sophisticated equipment, but those products sell best in high-wage countries where industrial buyers are looking for maximum productivity.

Western Europe is increasingly in the sights of Chinese companies. An early warning came in the form of Shenyang Machine Tool Group's purchase late last year of German machine-tool maker Schiess. Although Schiess was bankrupt and had 2003 sales of only $26 million, its acquisition gives Shenyang a measure of technology and marketing reach. It also showed that Chinese companies are serious about breaking into the European market. Given that the Chinese have already shown a remarkable ability to build whole industries from scratch, it could be only a few years before they are challenging German companies in the premium segment of the machine-tool business.

Germany has a history of squandering its dominance in sectors such as pharmaceuticals through management complacency and bad government policy. But it doesn't have to be that way this time. Government needs to invest more in training engineers, who are scarce despite record unemployment. And German companies must remain innovative while seeking maximum cost efficiency. Eastern Europe presents German companies with a convenient location to build at low cost and compete better on price. Properly managed, the rise of China presents as many opportunities as threats.

    Before it's here, it's on the Bloomberg Terminal.