© REUTERS/Aly Song

Capitalism has come to end. They’re saying it on TV, on Facebook, all over social media. It’s all going down the tubes, the whole thing’s a write-off. It’s all over now, obviously. So they say.

The same judgments, all over again. The same three-ring circus. But these misdiagnoses also form part of our Western cultural canon. These endlessly recurring critiques of capitalism are vague, so vague that they say more about the critics than the subject  that has them so concerned.

Are humanities and social science elites insulted that filthy lucre rules the world, rather than their own utopias and visions? Do the critics really know what they are criticizing? Can they say what kind of economy should take the place of capitalism? Can they put something forward capable of achieving anything like the prosperity enjoyed now in the West, in China, or in India?

Do they really have alternatives capable of providing the “greatest happiness to the greatest number,” as  John Stuart Mill put it? Or is their passionate negation meant to cover up their failure to develop sustainable alternatives?

These are not rhetorical questions, especially not now, in an epoch of pandemic and recession, which forms the background to the transformation from an industrial society to a knowledge society. Anyone who puts the question: “Is old-style capitalism still fit for purpose?” (meaning, of course, the market economies of the industrial nations) must be able to supply something better than what they so glibly criticize. But the same is true for die-hard defenders of the status quo. Pro-capitalist and anti-capitalist positions have become institutionalized and self-referential. What we need is something else: accessible capitalism. This type of capitalism must find its own way forward, businesslike but putting trust in people.

This is what I want to write about here, a third way, a market economy, capitalism for a self-conscious and self-confident civil society. Civil capitalism, which can pave the way for an open knowledge-based society.

But before getting into that, we should analyze relations as they currently are, figure out what we have at our disposal. Another capitalism is possible, but only if we are clear what we are talking about.

Self Determination

We owe John Maynard Keynes the insight: “the difficulty lies not in the new ideas, but in escaping from the old ones.” Old thinking now is industrial culture and the economy of hard work. The word industry, coined from the Latin industria, underlies that economy, which brought us everything we came to regard as normal, including mass production and the society belonging to it. Over the course of two hundred years, things have gotten so mixed together that it is hard to see the wood for the trees. But as Peter Drucker, visionary thinker of the knowledge economy, would put it, this state of affairs is actually a precondition for productive knowledge; it shapes the capacity of knowledge to “recognize connections.”

In other words, it is about understanding complexity, rather than reducing it to nothing. Digitization is nothing less than the continuation of automation processes which, to all intents and purposes, have gotten rid of routine work. Just as machines are replacing human power, network and algorithms are turning on their own inventors. If you only see a dystopian future, you don’t have enough imagination: what remains specific to human beings, something of which they have an infinite supply: individual work deriving from their personality and their own talents. No longer will we do the work ordered by others, “personally dependent” and “in service to another,” as German law on employees (in German, the word translates as “work-taker,” a telling phrase) would have it. Instead, they sing “intellectually and emotionally, we will work on our own account.”

None of this is entirely new. If we think of industrialization as a family, the most successful siblings have been automation and the division of labor. The latter always means specialization. The more you know, the more independently you can work. This is why knowledge is power, more than ever now, when it is combined with personality, individual know-how, and expertise. This development will advance all the more quickly if others can also have access to the benefits of specialization, as far as possible without barriers.

When ability creates a context, a market arises. The market economy is simply successful communication between those who have an ability and those who need that ability to fulfill their own needs. The knowledge economy cannot exist without participation and cooperation; for its part, this kind of participation requires self-confident, self-conscious agents at every level. This is something rather different to the “iron cage” described by Max Weber, with its older forms of dependency.

Reason versus Passion

Capitalism is not what has created bottlenecks within industrial societies. On the contrary, capitalisms are tools for openness and flexibility—so flexible that even using “capitalism” can sometimes be misleading. For this reason, social scientists tend to suggest that capitalism is an “essentially contested concept,” i.e. one that is constantly under challenge. The concept and its meaning are fought over in terms of people’s deepest worldview. But the “market economy,” a more concrete term for what we are talking about, is an event, a process in motion.

If something like this runs up against passionate republicanism, things can get problematic. Anti-capitalism is pure republicanism in the French Revolutionary spirit, in other words Enlightenment turned back on itself. The Revolution wants to create equality and pluralism, in others words, it wants to tap into complexity. But this quickly gets out of control, with the emergence of a politics of feeling, which tip over into simple patterns and explanations.

The current transformation makes this more visible than ever. What is at stake here are solutions for a mass society, simple collective answers. It is not capitalism in the dock, but rather the political simplifications, the reducers of complexity, the equalizers, the levelers-down. Our culture is on their side, let’s not kid ourselves.

For most people, pluralism and its systems are regarded as a threat. But the knowledge economy, like its civil society, functions according to other patterns. It is about grasping complexity, not reducing it any further. Less-is-more, the battle cry of the present day, is pure nonsense.

Even in a place where the boss—this is a good thing—puts more store on quality and the satisfying of personal requirements, instead of pure quantitative growth, as in industrial and consumer society, that is not something “less” in the sense of a new “overall view,” instead, these movements are on to something more, as prosperity leads one to want more than just more of the same.

In 1941, Abraham Maslow developed his pyramid of human needs. It is composed of five principal levels: existential needs, security needs, social needs, individual needs, and, finally, self-fulfillment. Our ancestors had their work cut out to meet the first three levels of needs. But human beings are more sated now, and better off. They want to be seen, they demand the fulfillment of their own personal needs.

We see this every day: everywhere, respect and recognition as a person, as a gendered person, as a colleague, is becoming ever more important. At the top of the pyramid stands Maslow’s self-actualization, which means optimally unfolding one’s own talents, including for the well-being of others.

Abundant mass production and automated routines are no longer enough to assuage needs at this level. As with industrial capitalism, they are at best a foundation. Quantity gives way to quality. The market economy is a pluralistic system, which can only be created with cooperation, differentiation, and joy in innovation. It is the operating system of an open society. Totalitarians, dictators, distant elites—they get on just fine without capitalism. But everyone else who wants their share of prosperity, the chance to make a go of things. It is not about the abolition of the system, it is about reinterpreting it. And making use of it.

Ruses

In his brilliant The Dynamic of Capitalism, French historian Fernand Braudel gave us perhaps the best definition of “the system,” which he called the “sum of ruses, processes, habits, and efficiencies.” This is not a doctrine of stasis at all. It is not the theory that anti-capitalists and method-obsessed economists are so eagerly seeking. Anyone who has tried to precisely describe the essence of capitalism has proven little more than that it cannot be done.

Max Weber sought the essence of capitalism in religion, in other words, in culture. This was also Braudel’s path. But this trail is only approximate, it only works in combination with one’s own experiences in dealing with behavior in the market economy. The tool assimilates to cultures, it coalesces with them. There is no one capitalism, there are hundreds of them. One study, which economic historian Werner Abelshauser is fond of quoting, identifies more than 750 varieties, all substantially different. Culture and social customs determine the economic toolbox. All capitalisms are the image of the cultures in which they operate. Globalism, in which cultural differences allegedly no longer exist, only seems strong if you don’t look too closely. Everywhere, cultures are the real rulers, the interpreters of market-economic methods and their ruses lead to highly variable results. Unification attempts regularly fail.

Japan’s form of capitalism, for example, is strongly focused on the state, incorporating the traditionally strong relation between citizens and the government. American variants are happier with risk, they take their lead from the individualist pioneer. China’s capitalism established the state as its own enabler, which attempts to achieve prosperity goals with the help of a highly dynamic (and often brutal) industrial capitalism. “Rheinisch Capitalism,” a variant closely associated with the history of the Federal Republic of Germany, is the social market economy which demands participation: “Welfare for all,” as Ludwig Erhard defined it.

This core is lost because of struggles over capitalism, which are basically culture wars, religious wars in a way. Neoliberalism is turned into a perfidious conjuring trick of the economy; in fact, the term refers to the “social liberalism” described by the German economists Walter Eucken and Wilhelm Röpke. The aim of social liberalism was to put the tools of the market in the hands of as many people as possible, in order to achieve more self-actualization, more self-determination, and more freedom. Systematic criticism of and opposition to market economies are fed by the primacy of the state and its institutions, over and above the free market. This leads to the opposite of what many critics intend: an expansion of the rights of the free individual.

Even today, many people live in a world of the oikos, the household economy, whereby a strict but fair father hands out whatever is available. Since ancient times, this has been the favored concept for thinking about economics. The claim it makes is as follows: there can be no more than this. The cake can only be divided up once, and we should do so as fairly as possible. “Fixed pie” is what economic psychologists call it: the belief of all those who never learned to bake.

Moreover, this belief is ahistorical. Human cultural development has always built on our capacity to use thought, renewal, transformation, and development to make more out of less. As a species Homo Faber has been successful, but it not very self-confident. Uncertain people cling to power, which promises security. There oikos is recommended, because power must be distributed. Shouldn’t enlightened people take it over themselves, instead of subjecting themselves to structures which are so hostile to innovation and emancipation?

In 1848, the Communist Manifesto by Karl Marx and Friedrich Engels conjured up the spirit of the bourgeoisie and its economic tools, through which man is “at last compelled to face with sober senses his real conditions of life.” Marxism, says the Manifesto itself, is “sweeping away all long-standing fixed things.” In other words, it helped to get rid of the Ancien Régime. That spirit consists of reason, sobriety, pragmatism—the whole Enlightenment schtick, in other words. Thinking for oneself, Kant’s goal for the Enlightenment, is not an end in itself. It should constantly critique, challenge, and test reality anew.

A civil society worthy of the name knows how to help itself: it designs. Almost all conspiracy theories, on the extremist wings of both left and right, are based on economic illiteracy. Marx and Engels were not the first and will not be the last who knew that there is no freedom without economic self-determination. Successful emancipation always means one thing: to free oneself of outside control and dependencies. Self-determination cannot be delegated to authority or ideology. Whoever wants freedom must understand economics, and know how to apply it. That is the spirit of civil society, of civil capitalism.

The Industrial Comedy

In this way, the theater of Western anti-capitalism, so often filled with boos, in fact presents a comedy of mistaken identity. If people knew what the market economy, in other words: capitalism, actually is—a system leading to the acceptance of the individual and of pluralism—maybe they would applaud, who knows? But they perceive something else, and in fact this other thing, which has disguised itself as the market economy, is not something we can use as an operating system. It is industrialism, also called industrial capitalism: the figure who stands between us and a successful transformation of the economy.

Industrialism does not need people to think for themselves. It needs a norm-bound, regulated society, collectives with interchangeable individuals. It needs command and control structures, and it needs a strict state to regulate, to create the famous/infamous conditions for “investment security,” the thing endlessly demanded by business associations and lobby groups. In this variant of industrialization, the primacy of politics is never questioned. If sales don’t take off, they demand subsidies and purchase bonuses. Education purely services production and its subordinate areas. It is not a question of learning to learn, in other words, of thinking in new and innovative ways. The focus, in fact, is on educational collectivism, or, fulfilling the plan.

Industrialism has no interest in emancipating human beings, although this is a delicate paradox as it does make a contribution to it. In other words, it first creates the material basis necessary for its own super-secession. This, as Maslow would regard it, takes us from the first three secure levels of his hierarchy up to the upper two levels, where human beings can be what they are meant to be: self-determining.

Nothing less than this is at stake. We are lacking advocates of civil society—who should always also be civil capitalists—to take economic fate into their own hands. In this way, hundreds of millions of people have escaped poverty in recent decades. It was not passion and not ideology which made such a fundamental change to circumstances in China and India. It was the sober gaze of the market, here so misunderstood and unrecognized.

“The unified world has become a real thing,” wrote Joschka Fischer in his foreword to Jagdish Bhagwati’s In Defense of Globalization. A clever, hopeful book, which soberly collates evidence for the successes of the “system,” despised by so many in Germany, because they do not understand how much their own lives are dependent on this system for the continued existence and functioning of what they criticize. The alternatives to constitutive capitalism are always close at hand. They include violence, poverty, hunger, and dictatorship. Let us look soberly at these facts and at our social relations. We do not need to force ourselves to do so. Reason is enough. Let’s make sure this resource does not run out. Let us increase and multiply it.

The post A Future History of Capitalism appeared first on Berlin Policy Journal - Blog.

Big is beautiful—so goes the claim of many European business leaders and German Economy Minister Peter Altmaier, when they talk about Europe’s corporate position in the world. The European Commission’s controversial February 6 blocking of a planned merger between the rail businesses of Siemens and Alstom has brought the issue of size back into the headlines—with Altmaier and his French counterpart Bruno Le Maire arguing that the merger was necessary to compete with giant, state-supported Chinese companies.

It’s true that EU companies remain highly competitive globally and very successful exporters. It’s also true that the EU continues to be a very open economy with a trade surplus. Yet, despite this, there is a fear that European companies find it increasingly difficult to be on top of the global value chains—or, put differently, to be global leaders. And despite the successes of European companies in general, there are only nine firms from the EU in the top 50 of the Fortune 500, compared with 21 firms for the United States and twelve from China.

The picture among the top 100 Fortune 500 global companies is even more gloomy: 37 firms from the US, 23 from China and 22 from the EU. Moreover, not one of the world’s top 20 technology firms, covering sectors that are central to the success of whole economies, is from the EU, while there are eleven firms from the US and nine from China.

Europe clearly lags behind its global competitors in the platform business, and forecasts are no better: 70 percent of the global economic impact of AI is expected to be concentrated in North America and China. Many argue that EU-based firms simply lack the critical scale to compete.

Careful Thinking Needed

How can this problem be addressed? Some argue that the EU should change its competition policy. Merger control should become less strict, according to a recent study by the Federation of German Industries (BDI) on China. Moreover, merger control should become more “dynamic,” i.e. it should take account of possible future competition effects, and more “flexible,” to address concerns beyond potential anti-competitive effects, such as environmental, social, or other concerns.

Europe’s merger control laws may or may not need reform. But asking the Commission to so suddenly abandon its approach and to go against the letter of the Merger Control Regulation is certainly wrong. Moreover, careful thinking is needed as to avoid undesired effects of political intervention in specific cases.

European consumers still benefit from relatively low mark-ups thanks to high competition, but this could be easily squandered if merger control were relaxed. And one should also not be naïve about the benefits that larger companies would enjoy when entering a market like the Chinese one, where access is highly regulated and limited.

Sharpening State-Aid Control

Rather, European companies and consumers would benefit more from the following measures than from lax merger control.

First, applying a form of state-aid control to foreign companies needs to be made more effective, both in our markets as well as extraterritorially. EU competition law should be applied in a non-discriminatory way, regardless of the origin of the firm; if the market is distorted, the case should be pursued. The Commission could become more assertive in its enforcement, but for that to be possible the EU’s legal framework would have to evolve significantly, a point also recently made by BDI.

The EU cannot apply state-aid rules to foreign governments, and there is currently no systematic, effective, or well-founded way for the application of EU state rules to firms that operate in EU markets but receive state support in other jurisdictions. Yet it is possible to imagine an instrument that could be applied to foreign firms that benefit from state support in a way that creates an unfair competitive advantage that European companies cannot match. EU law should seek to ensure a level playing field for all companies.

The WTO agreement on subsidies and countervailing measures provides a platform for international collaboration that could help the EU address subsidies that distort international trade. However, it suffers from three main problems: the notification of subsidies is not fully transparent, and its efficacy is limited; the remedial action is slow and complex; and EU state-aid rules apply to both goods and services, whereas the WTO rules apply only to goods. In economies increasingly driven by services, networks, and data, focusing only on subsidies in the goods sector is insufficient.

Investment control regulation can be used to restrict the entry of foreign corporations that receive distortionary state support. But a transparent process is needed in order to avoid the misuse of instruments. Their existence, as such, can discourage unwarranted behavior. Yet, they must be clearly restricted to well-defined concerns, such as security concerns, with objective criteria, to prevent becoming just a simple tools for protectionism.

Toward a Proactive Investments

Second, Europe should go beyond defensive measures and more actively pursue a strategy that bolsters investment and innovation in Europe, while creating the conditions for firms to scale up in a well-integrated single market.

Europe needs a multidimensional mix of policies to strengthen and deepen the single market, which is still fragmented when it comes to services. Sufficient market financing should also be ensured so that firms can expand their operations and compete efficiently on a global scale—for which integrated and deep capital markets, including for venture capital, are needed. There is also a need for more risk-taking and for enhancing business and investment conditions in a number of countries.

The EU’s R&D spending is still at only 2 percent of GDP, compared with 2.8 percent overall in the US. Moreover, North America and Asia are the front-runners in private investments on Artificial Intelligence. This dark picture is a direct result of a lack of an effective strategy, not only for European investment but industrial policy as a whole. The EU’s global competitors long ago adopted ambitious AI plans, where industrial policies and public/private investments have a prominent role. And after Brexit, the state of AI in the EU will be worse, as London remains in the lead for AI companies. This makes a European strategy all the more important.

Strengthening Europe’s Universities

Finally, it should not come as a surprise that Europe is losing the technology race, given that its universities lag behind the top performers. For example, in mechanical engineering, the best German university, Aachen, ranks only in the group of 51–75-best worldwide, well behind twelve Chinese universities, according to the Shanghai ranking. Outside the United Kingdom, only Milan and Leuven rank ahead of Aachen among EU-based universities. Do Germany, France, or the EU have a strategy to address this problem?

Global competition is indeed becoming tougher, in particular with China increasingly leading in key technology sectors. And Europe needs to face that competition. Defensive instruments to address state-subsidy concerns are part of the solution; relaxing merger control is probably not the answer. But the real question is whether the EU will strengthen its single market, increase R&D spending, regain its leadership of universities and design a true and integrated AI strategy.

Big may be beautiful, but the strategic priority for the EU should be to become a front-runner in innovation and the adoption of new technologies. For that, it needs investment, research, and education rather than European champions.

The post Red Herring & Black Swan: European Champions? appeared first on Berlin Policy Journal - Blog.

© REUTERS/Fabian Bimmer

The German export-oriented economic model is under attack this year: Germany is caught between tough American protectionism and aggressive Chinese industrial policy. The US government is threatening to impose painful sanctions on key German export goods, such as automobiles, while China’s industrial policy is focused on acquiring important industrial technologies, and eventually replacing existing foreign technology leaders in the automotive, engineering, and chemical industries.

Because of the sizes of their markets, the United States and China unquestionably have the tools to hurt Germany’s export-oriented economy. The new German government under Angela Merkel will have to counter the effects of the US-Chinese squeeze.

First, German dependence on exports to the United States and China must be reduced. The focus should be on strengthening growth forces – and not just in Germany, but Europe as well. All euro area countries except France, Finland, Cyprus, and Belgium have current account surpluses, , and Germany’s surplus amounts to almost 8 percent of its GDP. The euro area as a whole has a surplus of around 3 percent of GDP. These external surpluses are no longer sustainable in a world in which the US president is threatening to launch a trade war and the World Trade Organization can no longer regulate open markets in key economies.

Germany’s capital investment is lagging behind. Even without this acute pressure, it would be in Germany’s interests to set domestic growth forces free. German business investment has been weakening for years. German gross investment in the industrial sector has been lower even than in France or Italy since the start of the millennium. A timely and feasible step would be to massively improve the rules for depreciating assets on capital, software, and research investments in the German tax code. This is all the more necessary now as US corporate tax reform will allow companies to immediately depreciate 100 percent of their expense for equipment and building upgrades.

Beyond reforming the tax code and lowering other regulatory barriers, Germany will have to accelerate the development of public infrastructure. Improvements are urgently needed for the country’s roads and public transport infrastructure, as well as its data infrastructure and broadband network. Schools and universities could use more funding as well. The increased availability of both private and public capital will also help raise wage levels in Germany. After all, capital complements most labor activity. This set of measures would promote domestic growth and reduce dependence on exports; the resulting growth in Germany would also help its EU partner countries by increasing demand for their products.

Promoting Infant Industries

Second, German innovation policy must also make a real leap forward, especially in the digital economy, so as not to leave the future of technological change entirely to others. American and Chinese IT corporations are in the process of dividing up world markets, setting technological standards that will be associated with huge licensing revenues in the future. They are also making significant advances towards the technology of the (near) future: artificial intelligence.

At the moment, neither Germany nor Europe has a lot to offer in terms of a digital economy. The EU’s Digital Single Market is not progressing. As early as 2019, Europeans will become painfully aware of the shortcomings in their networks’ innovation policies when the Chinese company Huawei begins to install 5G mobile technologies in Europe, a prerequisite for networked industrial production and autonomous driving.

Europe needs a much more ambitious and active digital innovation policy, one that includes the targeted promotion of European “infant industries,” for example through the development of larger venture capital markets. Research shows that scaling companies is more difficult in Europe than in the US due to lower access to venture capital in all industries. With regards to critical infrastructures, there should be no taboo on the targeted support of currently weak European 5G developers, such as Nokia or Ericsson. If European semiconductor and mobile network companies disappeared from the markets, after all, dependencies on US and Chinese technology providers would not only create security risks, but would permanently reduce European innovation capacities.

European governments will therefore need to fundamentally rethink their innovation policies, and in particular their digital policies, in order to counter the rush of American and Chinese companies and innovations. The German coalition agreement does hint at the importance of research, but it gives the impression that rather marginal changes are being considered, when a qualitative change is needed. Company- and market-driven “innovation from below” will be necessary but insufficient; digital transformation requires new, state-financed infrastructures, targeted support measures, and educational offers as well as continuously adapted market rules provided by governments and parliaments. Public innovation policy must simply become more ambitious and think in terms of bigger goals and dimensions. Substantially strengthening research and development spending in the European and German budgets is only a first necessary step in this direction.

Screening Foreign Investments

Third, Germany should campaign for a robust foreign trade policy in Europe. On the one hand, this is about adequately examining security interests in foreign investments and acquisitions and flanking them with a pan-European coordination office. On the other hand, it is also about protecting strategic technologies from being taken over through market manipulation practices. For this task, the competencies of the EU Directorate-General for Competition should be strengthened. It is completely unacceptable that foreign top dogs operating with state funding from closed domestic markets should be able to drive European companies out of the European market.

Germany must stand up for open markets and fair trade practices more decisively than before through the EU’s Directorate-General for Trade, without weakening the European institutions through unilateral action. European Trade Commissioner Cecilia Malmström is doing a very good job, not only in her negotiations with the United States and China, but also in establishing new strategic trade relations with, for example, the Latin American Mercosur, along with a free trade agreement with Japan. Europe should build further partnerships and, at the same time, sharpen its trade policy instruments to defend itself in the case of conflict and represent European interests more effectively than before.

Germany can no longer avoid an economic policy correction in the face of the dual pressure coming from the United States and China. The new German government has to act now if it wants to defend domestic industries from unfair competition while releasing Europe’s own growth forces.

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© REUTERS/Hoang Dinh Nam/Pool

It was some 100 years ago that a Japanese doctor, Hakaru Hashimoto, first described a troubling malady afflicting patients. The symptoms included listlessness, fatigue, and bouts of depression. Hashimoto had discovered a widespread autoimmune disorder affecting the thyroid gland. The eponymous condition cannot be cured, only aided by medication. Those suffering from Hashimoto have to adjust to living with diminished energy.

It can be argued that the doctor’s native country is suffering from the very same malaise. For a generation now, the Japanese have been yearning to return to the boom years of the 1970s and 80s, when the world and many Japanese believed their country could achieve the same grandeur China is ascribed today—the ability to conquer the world. The Japanese economy has witnessed a series of ups and downs but has not regained its swagger. Meanwhile the Japanese themselves and indeed the world still seem to see the Japan of today through the lens of the country’s boom days.

It would serve Europe well to look kindly upon Japan in its struggles. Europe and Germany in particular are suffering from many of the same symptoms, and Japan’s efforts to turn things around may provide an important blueprint. In Europe, most eyes are fixed upon China and India today, but among Asian economies, Japan is still the closest to ours.

The components of Japan’s woes are well known by now: stagnant economic growth, an over-dependency on exports, and soaring (public) debt on the one hand; a shrinking society and a growing chasm between rich and poor on the other; politically, a democracy facing real challenges to its governance and caught in a tricky position among neighbors in the region.

No Sick Man of Asia

And yet Japan is no sick man of Asia. Its challenges are not merely the result of failures, but also of important successes. Japan may not be a part of the current boom in Asia, but that is precisely because it was Japan that originally mastered it. And despite its woes, the country fares well in leading international benchmarks.

Japan ranked sixth in the Bloomberg Innovation Index in 2018, for example, while Germany came in fourth and the US in eleventh place. On the Human Development Index, Japan ranked 17th worldwide in 2016 (here, too, Germany landed fourth and France far further down at 21). While social inequality is a growing problem in Japan, it remains rather moderate by global standards. The country is ranked 22nd on the Gini coefficient of inequality register of OECD countries, between Italy and Australia. Germany, meanwhile, is ranked 13th. The United States is near the bottom (34), just ahead of Turkey and behind Russia.

Japan, it would appear, is suffering from first-world problems. Still, the extent to which these problems weigh on the country, and its economy, is unusual. Japan’s GDP in real terms has mostly stagnated over the last 20 years while the country’s public debt soared to 240 percent of GDP in 2017 (it is around 65 percent in Germany).
Meanwhile, Japan’s population is shrinking at record speed. If the current demographic trend continues, the country will plummet from 127 million people today to 87 million by the year 2060. In comparison, Germany will see a steady decline from 82 million to 68 in the same time period.

The fact that these trends affect Japan more than other wealthy countries is also reflected in the well-being of its citizens. In the UN’s annual World Happiness Report, Japan recently placed a lowly 51, alongside Russia, Belize, and Algeria; Germany ranks 16th. The studies show that many Japanese feel their country is not heading in the right direction. There is a lack of clear perspectives and opportunities.

Conflicting Interests

Part of the problem is that Japan finds itself in an uncomfortable position. Trade with China is currently the biggest opportunity for economic growth; at the same time, the rise of China is Tokyo’s biggest foreign policy challenge.

For years, the foreign policy debate in Japan has centered around both the commitment to the United States and integration in the region. At one end of the scale are the moderate pragmatists who advocate regional integration. They demand a more independent foreign policy, especially with an eye to China: They fear that cozying up too close to America will hurt Japanese interests. China is Japan’s biggest trading partner—in fact, the value of bilateral trade exceeds that between Japan and the US by more than half. And that gap is widening.

At the opposite end of the scale are the traditionalists, led by Prime Minister Shinzo Abe; they see a strong alliance with America as the highest priority. They believe Japan must work toward curbing China’s rise to prevent its powerful neighbor from becoming overly dominant—and that will only be possible with the help of Washington.

It would be as if Germany’s biggest trading partner were a booming, surging Russia—a Russia that is on the verge of dominating Europe economically and dethroning America as the most powerful in the world; a Russia where defense spending grows by double digits every year and which, at the same time, starts to make territorial claims on Germany and other European states. It is an imagined parallel, of course, but it helps to understand why Japan is lukewarm toward its budding partnership with China.

When Barack Obama was still US president, Abe knew he was on the safe side. Obama’s “pivot to Asia” was very much founded upon a strong alliance with Japan. Donald Trump has complicated the relationship, however; Abe was the first leader invited to golf with the new US president, but that show of friendship has brought Japan very little benefit so far.

Tools of Trade

The turmoil in the US has left Tokyo with no other choice than to take its fate into its own hands. The Trans-Pacific Partnership (TPP) provided the first example. Negotiated under the Obama administration, the TPP was to become the largest free trade area in the world, bringing together ten other Pacific Rim nations with the US and Japan. China was not invited to the club, which Beijing rightly saw as an attempt to rein in its influence in East and Southeast Asia.

After Trump’s withdrawal from the TPP, Abe’s government pursued a fresh deal with the remaining ten interested parties. The agreement, now known as TPP-11, is due to be signed in March. It is a striking success for Japan, not only because Tokyo led the negotiations. Its goal of creating a serious counterweight to China may not be achievable without the US, but the TPP-11 is an important signal that Japan supports global free trade and is capable of forging its own alliances.

Tokyo’s free trade agreement with the EU, called JEFTA, which enters into force next year, also shows that Japan is an important global player. Together, the participating countries in JEFTA account for around 30 percent of global GDP. Shinzo Abe described the agreement as “the birth of the largest economic zone in the world.” And JEFTA should bring significant benefit to Japan: According to a study by Germany’s Bertelsmann Foundation, it will generate growth of up to 1.6 percent of Japan’s GDP. Germany stands to benefit most of all the EU countries, with growth expected to reach 0.7 percent of GDP. It is not a game changer for any of the participating countries, but it certainly brings significant improvement and sends a signal of strength.

Abe’s Populism

Nevertheless, Japan’s possibilities are more limited than its economic power would suggest at first glance. This holds especially true in its own region. East Asia lacks the solid institutional basis that is taken for granted here in Europe. There is nothing in East Asia that comes close to the EU or NATO.

In all fairness, East Asia does present a unique set of circumstances. The size and proportions of East Asian nations are vastly different. China will never engage in European-style alliances in the region but rather pursue its own agenda; Japan is still so dominant that its neighbors fear integration would lead to domination.

Not to mention that today, more than 70 years after the Second World War, Tokyo still has not clearly distanced itself from its war-time atrocities—and that, too, worries neighbors. Nearly every post-war government in Japan has taken a revisionist stance on the country’s history, especially Shinzo Abe. Donald Trump’s former chief advisor Steve Bannon gave him the dubious praise of being a “Trump before Trump.” In reality, Abe is a far cry from the US president. But his aim to revise Japan’s pacifist constitution, restore pride in the country’s military traditions, and discredit “mainstream media” resemble the right-wing’s platform in the US.

In fact, Abe’s populist overtones have possibly prevented any party from gaining ground to the right of his Liberal Democrats. The populist sentiment he has stoked has served Abe well in cementing power at home. But abroad, he has harmed Japan’s image and deepened his country’s malaise.

Economic Strengths

Still, Japan’s technology and economy could emerge as possible bright spots for the future. Though economic growth has been weak, the country is well-positioned in key industries and has good opportunity to extend its advantage going forward.

For example, Japan regularly spends around 3.5 percent of GDP on research and development (R&D) . This is an extraordinarily high proportion, surpassed only by Israel and South Korea (in Germany, R&D expenditure has reached around 2.8 percent in recent years). Even in absolute terms, R&D spending in Japan—at around $180 billion—is among the best in the world, surpassed only by the US and China. German R&D spending, meanwhile, is around $110 billion a year.

Japan excels in robotics—it is currently the world’s number one manufacturer of industrial robots, meeting around 52 percent of global demand. This is nothing short of spectacular. While there is one major industrial robotics player in Germany (Kuka, which is now a Chinese-owned company), Japan’s Fanuc, Yaskawa, and Kawasaki Heavy are all competing.

Germany may have Siemens, but Japan has Hitachi, NEC, and Toshiba. A similar picture can be found in the chip industry and Japan’s electronics companies, which are growing and investing again after years of crisis.

Japan also has extremely ambitious goals in terms of energy and transport, including the evolution of hydrogen as an energy source. It is promoting this technology far more than any other country, and Shinzo Abe regularly speaks of a “hydrogen society” when talking about the future of Japan energy technology.
The focus on promoting new technology in the public and private sector has placed Japan on a unique path, turning the country into one of the leading drivers of innovation worldwide.

Robots for Guests

That spirit of innovation is too often overshadowed in debates and analysis of Japan. Outsiders struggle to shed the image of a directionless, listless Japan—a bit like Germany in the late years of former Chancellor Helmut Kohl’s leadership. Many are hoping the Olympic Games in 2020, due to be held in Tokyo, will jolt Japan back to life.

Even the best sports extravaganza in the world cannot change Japan’s situation dramatically, but it can certainly have a positive influence on its image. The games could provide a platform for the country to display its prowess in technology. That is why Tokyo has said it will prepare a small army of robots for the Olympics, to impress and woo foreign guests as soon as they arrive at the airport.

There is, for example, Cinnamon the humanoid who can talk to people and give directions; robotic stuffed animals translate into four languages at the airport while other robots help carry travelers’ luggage. Japan’s hydrogen technology, too, will be on display.

It may be entertaining and even useful. It could also serve as reminder to the rest of the world, that Japan is not on a detour. It is busy registering the results of its own success, and Europe would be well advised to pay closer attention.

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© REUTERS/Alexander Shcherbak/TASS/Pool

Russia is once again pondering its economic future. At this year’s St. Petersburg International Economic Forum, a new economic reform program topped the agenda. Developed at the request of Russian President Vladimir Putin by former Finance Minister Alexei Kudrin, the program is ambitious: it demands not only the privatization of the state-owned oil sector in the next eight years, but also reform of the judicial and administrative systems and cuts to the defense budget.

Some of these ideas sound like déjà-vu. Nine years ago, then-President Dmitry Medvedev’s modernization agenda captured the imagination of many European politicians and businesses hoping for a jackpot of economic opportunities, paired with improvements in the investment climate, the rule of law, and governance. These hopes were ultimately dashed with the return of Putin to the presidency in 2012. The innovation center Skolkovo on the outskirts of Moscow – originally intended to become Russia’s Silicon Valley – is a reminder of how grand economic designs à la russe can end in the dustbin of history. Will Kudrin’s reform plans share the same fate?

Kudrin is an ambiguous figure in Russian politics. He has been in and out of favor with the Kremlin, but remains one of the few critical voices allowed inside the echo chamber of Putin’s inner circle. In March 2014 he publicly calculated the costs of Crimean annexation as amounting to between $150-160 billion in capital flight alone.

Kudrin’s political career started in the 1990s in the city administration of St. Petersburg. Both Kudrin and Putin began working for the presidential administration in 1996. From 2000-11 Kudrin served as finance minister and has been credited for steering Russia through the financial crisis of 2008. In the eyes of Western financial institutions, he was a popular proponent of a market-oriented economy, representing the faction of moderate economic liberals within the Russian political elite.

Careful Navigation

In 2011, after Medvedev and Putin announced their decision to swap positions again, Kudrin refused to serve as finance minister in a cabinet led by Medvedev. He cited concerns about mounting defense expenditures, and was dismissed by Medvedev in a public spat. Since then, Kudrin has carefully navigated the Russian political arena. During the protests following the Duma elections in 2011 he sided with the protesters by criticizing the election procedures, but stressed the need for dialogue with officials. Subsequently, he founded the Civil Initiatives Committee, a civil society organization that falls short of being a political party, but represents a potential base for any future political ambitions.

Speculations about Kudrin’s return to politics, such as replacing Medvedev as prime minister, have never ceased. For the moment, being outside the government seems a convenient position because it allows for outspoken criticism of the current government’s economic policies. Unofficially, however, Kudrin has already returned to politics: In April 2016 he was appointed chairman of the board of the Center for Strategic Research Moscow, a think tank close to the Russian president, and tasked with developing economic proposals for the next presidential term.

Putin has so far avoided taking ownership of Kudrin’s reform plans and has also asked a rival faction around Boris Titov, the presidential commissioner for entrepreneurs’ rights, to develop parallel proposals. This allows for convenient cherry-picking. In contrast to Kudrin’s ideas, the proposals of the Titov faction advocate for greater state intervention – a Keynesian steering of the economy.

It is important, however, to consider the likelihood that either of these economic reform proposals will be implemented. Back in 2008, against the backdrop of the financial crisis, Medvedev’s reform plans enjoyed at least some credibility in the West. This was the reason why so many European countries forged so-called modernization partnerships with Russia, a concept Germany had been particularly keen on. Conventional wisdom had it that Russian economic reform was urgently necessary, otherwise the country would risk economic decline or collapse.

Reform for Legitimacy

In recent years, however, the Kremlin has demonstrated the opposite: a mediocre oil price and a comfortable buffer of stabilization funds – built up in better times by Kudrin himself – have kept Russia afloat without significant economic reforms. And a new social contract has emerged: In the absence of economic growth and prosperity, the pill has been sweetened with foreign policy adventurism and patriotic fodder for the hearts and minds.

Given Moscow’s wish for “normalization” of relations with the West, a new foreign policy adventure seems unlikely. And with Putin preparing for a fourth term in power, he must offer a substitute to entertain the population and the elites. More of the same is not the fabric grandiose victories are made of. The question of whether to reform or not to reform hence runs the risk of becoming the Potemkin facade in a play staged for the 2018 presidential election to simulate activism and debate in an otherwise stagnating domestic environment.

While Putin’s “winning” a fourth term is certainly not at stake, questions of voter turnout and legitimacy remain important. Discontent among Russian youth is simmering, as demonstrated by the protests following corruption revelations by opposition politician Alexei Navalny.

For European policymakers, the lesson to be learned from this is that Russia’s economic reform plans should be taken with more than a grain of salt. German politicians in particular, having met the Russian president for a personal tête-à-tête in St. Petersburg, should adopt a realistic perspective on the current state of the Russian economy. While Russia’s position in the world has changed fundamentally since 2008, the economic problems have remained the same.

In an economy where direct and indirect state involvement amounts to seventy percent, the vested interests of the political elite are too entrenched for significant changes to the current model to be made without endangering its power basis. In the best case, one can hope for some minor positive adjustments. In the worst case, Kudrin’s reform plans become just another chapter in the eternal play of Russian pondering about their economic future.

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© picture alliance/ROPI

What went wrong? After months of discussions over the pros and cons of a constitutional change to make Italy’s political process more efficient – a change that had the business world’s seal of approval – voters said no. A heated national debate ended in a resounding defeat for Prime Minister Matteo Renzi on December 4 of last year, and three days later he was forced to resign. Once again, Italy was left with a new government  – the 66th since the end of World War II. But the failed proposal and the reasons it fell apart have been swiftly swept under the rug.

In fact, complete silence has settled over the country. Renzi’s aborted reform plans are no longer discussed at all, as though the referendum never even happened. The parties that once supported the reform plan have returned to their traditional infighting, and the word “reform” has been stricken from the political vocabulary. In the meantime, lawmakers have been consumed by a new voting law and potential dates for a new election.

The clear 59.1 percent majority against Renzi’s reform plans may have been influenced by the Brexit vote and the US election, but there was also a uniquely Italian dynamic at play: Renzi had lost sight of growing social inequality and failed to understand the degree to which young Italians reject his policies, especially those who had suffered the most under the ongoing financial crisis. For them, it wasn’t a matter of constitutional reform – their vote was meant as a wake-up call for Renzi.

Too Big to Fail

Italy has lost its chance at a new beginning and rejected a constitutional reform that was fundamental to the health of the economy.

The country is “too big to fail” – too large and important as the third-largest economy in the eurozone and ninth-largest industrial state in the world to be allowed to collapse. While Greece is responsible for two percent of the economic capacity of the eurozone, Italy contributes 16 percent. The reform aimed to make administrative structures more flexible, legislative processes faster, and the political world more stable; it would have made Italy’s economy more competitive on the international stage.

Instead, the economy is stagnating, the banking sector is in crisis and public debt is staggering. Yet the outbreak of the disease began long before Renzi entered office in February 2014; the country’s recent problems merely represent its recurring symptoms. In reality, Italy has been suffering from weak growth, antiquated structures, and pernicious corruption for a long time.

Italy’s recession lasted three years after the start of the financial crisis in 2008 and had disastrous consequences. GDP has plummeted by eight percent, per capita income has fallen ten percent since 2007, and productivity is a quarter of pre-crisis levels. At the same time, debt has increased and the unemployment rate has fallen only marginally. Youth unemployment was still 40 percent as of December.

The crisis decimated the once-strong middle class, and growth has stagnated. Renzi does not deserve the blame for these developments, but he did not manage to improve the situation either. Italy simply has not managed the transition into the modern era.

In fact, the economy has lacked dynamism for some thirty years now. Real growth sank from 2 percent in the 1980s to 1.5 percent in the 1990s and 0.6 percent in the first decade of the 21st century. The largest economic contraction came in 2012. Now, deflation and weak domestic demand continue to stifle growth even further.

It’s a vicious circle: Sinking productivity and competitiveness demand higher public debt, which increased to €2.21 trillion in 2016. The EU Commission has demanded sustainable budget consolidation and doubts Italy’s willingness to cut expenses. And it’s no wonder the Commission is worried – if Italy cannot get its debt under control, the existence of the euro itself is under threat.

The emotionally-charged word “flexibility” has dominated the headlines for months now. In 2016 the EU Commission granted Rome a few exceptions as a one-time measure. In its 2017 budget, Italy designated certain expenses – including the costs of the continuing refugee crisis and the 2016 earthquake – as special expenditures and raised its deficit repeatedly. A culture war broke out between Europe’s North and South. Rome blamed austerity policies for limiting its growth while Berlin and Brussels criticized Italy’s unwillingness to cut expenses and the government’s ad hoc approach to economic policy.

Too Many Banks, Too Little Efficiency

The problems with Italy’s ailing banks are especially troubling. It is a sector that has avoided modernization for years; Renzi summed it up when he said, “There are too many banks.” Too many banks, too many branches, too little efficiency – for every million inhabitants, there are 502 bank branches, well above the European average. The problem stems from Italian mentality. Particularly in smaller villages and rural areas, businesses rely on personal contact, but this can have negative consequences. When the credit unions were saved in 2015, small savers lost their money because they trusted their personal advisers without reading the fine print on their accounts.

There are many reasons why the banks find themselves in this state – the macroeconomic environment currently affecting all European banks, the negative interest rate limiting profitability, the 2016 earthquake – but there’s one problem unique to Italy: bad loans. In total, the banks have amassed a record €360 billion of them.

Italian bank supervisors blame the recession for exacerbating the situation. It has become difficult for many companies to pay back their loans, according to Ignazio Visco, governor of the Banca d’Italia, and banks have had to take necessary precautions to ward off further disaster. But the process of restoring the banks’ health has taken too long. Carmelo Barbagallo, head of the Banca d’Italia’s directorate general for financial supervision and regulation, says the number of bad loans is gradually sinking, but the IMF and the European Banking Authority have observed Italy’s attempt to work through its mountain of bad debt with growing concern.

The institution with perhaps the greatest problems is Banca Monte dei Paschi di Siena. Founded in 1472, it lost roughly 60 percent of its value on the Milan stock market in 2016. The Siena institution was the worst-performing in Europe in the ECB’s stress test and at €24.2 billion has the highest amount of non-performing loans on its books.

Key investors, such as the sovereign wealth fund of Qatar, have withdrawn their funds, and shortly after Renzi’s resignation the final taboo was broken: the state stepped in to rescue the bank. According to EU rules established in the beginning of 2016, this should no longer be possible. However, Rome invoked exception clauses and pointed at the bank’s systemic role. For weeks now, the rescue package of €20 billion has been ready and waiting in a drawer at the ministry of economy and finance. In retrospect, it is clear that Renzi spent far too long passively observing the disaster unfold. He sat on the sidelines until Monte dei Paschi was nearly insolvent in order to escape the anger of the small investors (and voters) who would be forced to shoulder the bailout.

Reaching Global Markets

Today, banks are working to modernize themselves – but as in other industries, that can mean the elimination of jobs. And different industries have experienced vastly different rates of success when entering the global market. Some, like companies that deliver cars for the automotive industry, have been overwhelmingly successful in carving out niches for themselves; others have had more difficulty, due to insufficient innovation, development, strategy, or simply foreign language capability. “Businesses need to be able to rely on a modern institutional order, otherwise investments won’t come in,” says Boccia. With the referendum, they would have had it.

In addition to a long tradition of clientelism, Italy has been plagued by corruption and mismanagement, tax dodging, and a significant shadow economy. Financial regulators are taking their work seriously; the new Italian National Anti-Corruption Authority (Autorità Nazionale AntiCorruzione, or ANAC) has so far been successful – and yet there are daily media reports of new cases of corruption or abuse of office. The “Tangentopoli” bribery scandal uncovered extensive corruption in Italy’s highest offices 25 years ago, yet today, according to a poll conducted by the institute Demos & Pi, 86 percent of Italians believe corruption to be as ubiquitous in politics now as it was then, especially when it comes to procurement.

And beyond corruption, the country’s bloated bureaucracy and outdated justice system practically demand that businesses flout the rules. The Renzi government attempted to reduce the role of public administration by reorganizing the provinces, but the task proved Sisyphean in a country that praises the clever hustler who clocks in every morning and then goes to take care of other business outside the office. Resistance against any sort of change to increase efficiency is substantial.
Business requires faster reform of the justice system, both in civil and criminal law. At the moment, a judgment is only valid after three instances and often takes over a year to reach. According to the EU Commission, since 2014 an average of 500 days pass between the beginning of a civil trial and a decision. In criminal cases, the statute of limitations often runs out before a judgment is handed down.

Scandal-prone former Prime Minister Silvio Berlusconi was one of the greatest beneficiaries of this system, escaping countless times from tax evasion, corruption, perjury, and abuse of office charges. He was only once convicted, and even then escaped with nothing more than house arrest and community service on account of his age. Faster legal proceedings would also be a draw for foreign investors. A new law extending the statute of limitations, however, is stuck in parliament – and the ongoing electoral campaign prevents any serious legislative work.

Other numbers speak for themselves. Tax evasion currently amounts to €109 billion per year, and the shadow economy is estimated to comprise around 12 percent of business. To change that will be a Herculean challenge for any government. Twenty years of Berlusconi did little to strengthen civic cooperation or confidence in state institutions. As Machiavelli wrote in The Prince in 1513, “For the innovator has for enemies all those who derived advantages from the old order of things, whilst those who expect to be benefited by the new institutions will be but lukewarm defenders.”

“Made in Italy”

Not everything is going wrong in Italy. Minister of Economic Development Carlo Calenda pointed out, “We are in fifth place globally in terms of trade surplus, and set an export record of €414 billion in 2015. Many of our businesses are integrated into the global supply chain.” When it comes to structure and competitiveness, the northern parts of the country are not so different from Germany’s most successful states, Bavaria and Baden-Württemberg.

“Made in Italy” is a sure-fire success – the luxury sector is booming, and not only major fashion brands, but also the leather, design, food, and wine industries are doing well. Even in metalworking and electronics there are countless small and medium-sized enterprises that are fast becoming global leaders. The shift of Italian industry over the past decade into machine construction, robotics, and pharmaceuticals has strengthened connection to Germany, the country’s most important trading partner. German companies have 2950 branches in Italy today.

Meanwhile, Calenda has been undeterred in his emphasis on Industry 4.0, and industrial leaders like Alberto Bombassei from Brembo, a manufacturer of brakes systems, consider him “the right man in the right position.” Italy will make further gains as business and consumer confidence grow.
Renzi was accused by his opponents of pursuing political rather than structural goals, but his reform report card – with the exception of the referendum – isn’t bad at all, especially his modernization of the labor market in the face of massive opposition. This reform is not yet finished, though; bankruptcy reform and a competition law are still pending in parliament.

Italy can count among its virtues creativity, a knack for innovation, and quick problem-solving abilities. The Italians are adaptable and flexible in crises, and they possess a great deal of individuality and loyalty to their local region, rather than to the state. Their private saving rates are high compared to the European average. These are all factors that could help Italy manage a new beginning. The country has gotten by so far, though it is losing time. Italy seems to be experiencing the bumblebee paradox: According to the laws of aerodynamics, a bumblebee should be too heavy and its wings too small to fly – nevertheless, the beating of its wings produces a large vortex that generates enough lift to keep the insect afloat.

Two possibilities still frighten investors. The first is a further advance of Beppe Grillo’s Five Star Movement. The euroskeptic party is nipping at the heels of the governing Partito Democratico (PD) in the polls. In 2016 local elections they took over city halls in Rome and Turin. But their victories are costing them, especially in the capital: the politically inexperienced and scandal-plagued mayor Virginia Raggi appears to be completely overwhelmed.

And then there’s the specter of an “Italexit”, or Italian exit from the eurozone. The American Nobel Prize-winning economist Joseph Stiglitz set the tone of the international discussion: “Italians are starting to realize that Italy doesn’t work in the euro.” And former Chief Economist of Deutsche Bank Thomas Mayer agrees. “Should Renzi lose on December 4, Italy may set a course for an exit from the currency union,” Mayer predicted.

That is not, however, the picture so far in 2017. Economic numbers are slowly beginning to improve, and Renzi’s temporary successor, Paolo Gentiloni, is concentrating on fighting poverty and creating social solidarity. As its first act in office, the government issued a decree to implement school reform and marriage equality, and negotiated an aid packet for southern Italy. Another earthquake in central Italy early this year, however, put the government back in crisis management mode.

Whether Grillo and his party manage to pull off an upset, or whether Renzi returns to implement further reforms, one thing is evident: the era of clear majorities is over. There will be long coalition negotiations, as no political party is currently capable of governing alone. Italy is suffering from a case of “vote-itis,” says Giuseppe Vita, president of Unicredit bank and chairman of the supervisory board of Axel Springer – all the more reason for electoral reform.

Still, the powers of change are at work. In Vita’s words, “The light at the end of the tunnel is daylight, not an oncoming train.”

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Artwork: Dominik Herrmann

The United States also has an advantage when it comes to energy. The US produced more natural gas in the last year than Russia’s Gasprom, and more oil than Saudi Arabia. But Europe? We are still on the hunt for a reasonable energy strategy – one that envisages wind farms where there is wind and solar panels where there is sun, while creating a functional energy transfer network to ensure that the energy produced is available where it is needed. Until something changes: US 2; Europe 0.

Next up for consideration: capital resource strength. Microsoft, Google, Facebook, Amazon, and Apple are downright young companies, all between just 15 and 40 years of age. But their total stock market value in New York is twice as high as that of the top thirty German companies combined. Here we speak of € 30-90 billion capitalization; there, it is $300-600 billion. Sorry, Europe – 3:0.

How about digital superiority? It is a category where we have our strengths: Sweden’s Ericsson, France’s Alcatel-Lucent, and Germany’s own SAP, based in Walldorf. Bosch was producing mobile telephones 15 years ago, Siemens just ten. Global leader Nokia held a 50 percent worldwide market share just five years ago. (The company has since been purchased by Microsoft.) The cell phones of yesterday, however, have morphed into the smartphones of today, produced by Samsung, LG, or Apple. They use data from across the planet, and today whoever has the data has the power. Germany may have SAP, good universities, and a roaring Berlin start-up scene, but we have lost the IT leader race.

With a score of 0:4, then, Europe is desperately in need of a comeback – a push for “Industrie 4.0.” The wrestling match to establish a decisive role in industrially significant digital platforms has already begun, and the winner could walk away with market dominance similar to what we are already familiar with on the web. Europe’s industry has no choice but to contribute substantially to the development of the next generation of digital platforms – the ones that will replace today’s search engines, operating systems, and social networks.

Such digital technologies will change existing business models significantly, upending established industries like the automobile industry along with the cultural and artistic industries. Value-added chains will continue to evolve; the borders between products and services will blur. So-called intelligent products with internet connectivity will become significant not only for their functionality, reliability, and adaptability, but also for the way in which they will change the behavior of consumers themselves – the automated car will likely prove an excellent example.

The Americans have a clear strategy: they want to push this reindustrialization forward on the backs of low energy prices and existing digital services, thereby carving out an overall economic leadership role from a place of digital superiority. And nothing against our allies, but this strategy ultimately harms Germany.

Take the auto industry as an example. The worst-case scenario in ten years would look something like this: car bodies are no longer produced from sheets of steel or aluminum, but rather from carbon produced in the US. This alone would result in a loss of a serious amount of demand for German machine tool manufacturing. Batteries are produced in Asia. And an electric motor doesn’t need gears – further bad news for the German auto parts industry. Finally, the digital components are naturally produced in Silicon Valley. German industry is facing a terminal diagnosis – it just doesn’t know it yet.

All of Europe Is Afflicted

The links in today’s value-added chains connect all of Europe; combined with advancing industrial digitalization, this means no single country can solve these problems alone. Yet massive gaps exist between various EU member states, between high-tech industries and traditional sectors, and between large corporations and small and medium-sized enterprises when it comes to the use of digital technologies.

Just 1.7 percent of all businesses in Europe use digital technologies to their full extent, and 41 percent of companies do not use them at all. The former number needs to rise at least to 30 percent should European industry hope to be any match for its international competition. And we need a wave of digital innovation – and not only in high-tech fields, but also in traditional sectors like agriculture and food production.

Such initiatives already exist to a certain degree, they simply need to be Europeanized: Germany’s “Industrie 4.0”, the Netherlands’ “smart industry”, France’s “Usine du Futur”, the UK’s “industrial strategy”, and Sweden’s “Produktion2020”. The problem now is less about integrating more digital technology on a national scale – within German or Swedish industry, for example – and more about pan-European adoption. The consolidation of these initiatives under an EU roof would not only ease the exchange of valuable experience while minimizing the risks for each country individually, it would also lead to the creation of a single EU standard that would enjoy worldwide acceptance. In fact, Europe is already well-positioned to play a leading role: it is already a market leader in industrial robot technologies and automated manufacture (30 percent global market share), in embedded digital systems and product design software (33 percent), and in 3D- and laser-based manufacture (25 to 40 percent).

Comprehensive Broadband Coverage

For a European Industry 4.0 strategy, we first need a reliable digital infrastructure, and that means comprehensive broadband coverage. Connected cars, automated driving – these can function only with 5G networks and a pan-European infrastructure, one that spans from large cities to villages. Any small town without broadband is doomed. Its demise lies not in the opening of the nth bypass road, but rather in its lack of invisible investment: satellite, wireless, and broadband networks. This will be our generation’s challenge.

It does not matter whether we are talking about eHealth, digital surgery, automated driving, machine-to-machine communication, or factory 4.0 innovations; the amount of data we will need to transport is poised to explode – and not on a linear basis, but rather an exponential one. We need speed, we need quality, we need capacity. We shouldn’t talk in terms of 3 MB/sec, nor even of 30 or 50, but rather 100 to 1000 MB/sec. We do not have 30 years to achieve this, either – we must be ready in the next five to eight years.

Here we must also include targeted investment in research and development. On the EU level, we have budgeted € 1.5 billion per year for digital technologies and industrial digitalization. Yet if we want to digitize industry Europe-wide, we will need the support of the member states. They must invest on a massive scale in the expansion of their digital competency and knowledge centers, as well as open the door to digital integration in small- and medium-sized enterprises. Investment by member states and regions must reach at least ten times the level of EU funding in order to bear real fruit.

In the end, it is not only the production of information and communications technology itself whose value is significantly influenced by digital technologies; in the digital factory, investment releases stifled potential, creating space for creativity, productivity, and greater resource efficiency.

Digital Competency Gaps

This leads us to the second point: education. Digitalization will create new, highly specialized jobs, while at the same time eliminating many others – in administration and management, for example. The need for new, well-trained workers in industries like big-data analysis, cybersecurity, and cloud computing is growing massively at the moment. Yet the digital skills gap in Europe is increasing: this year alone 500,000 expert positions will go unfilled. Creativity, communication skills, and the ability to learn new production methods are becoming increasingly important, and it’s high time that they appear on university syllabi.

The Germans, on average eight years older than Americans, are burdened by nearly an additional half-generation of non-digital natives. Continuing education would help – Germans already in the workforce may never become IT specialists, but the CEO, the toolmaker, the factory foreman, the bookstore owner, and the master butcher could become more productive with the acquisition of digital skills. This is the only way we can ever overcome our deficit compared with the US in the medium or long term.

Warnings, Punishments, and Expulsions

Third, we need comprehensive, systematic data security. We created and saved as much data in the past two years as in the entire history of mankind until that point. We must expect that data volumes will continue to increase by 60 percent annually. In Germany, this has led to (justified) greater concerns over data security, but we must remember that any location prioritizing perfect and comprehensive data security is no longer an attractive location for data use and storage. Big data and data security are not necessarily mutually exclusive, but a pragmatic balance of their interests must be achieved.

Furthermore, this balance must be a work of pan-European cooperation – while many things can be resolved nationally, the idea of national digital policy is absurd today. When I took office in Baden-Württemberg’s state parliament in 1984, we had just negotiated our first statewide data security law. Does anyone today still believe that such a law can protect their data? Baden-Württemberg’s data security law will neither be observed by Facebook, nor translated, nor applied, nor utilized as precedent – it will land in the trash bin. As long as Europe has 28 fragmented data security silos, Apple, Facebook, and Amazon will continue to shop around and settle for the country with the laxest data security laws available. They will suck up European data, save it, and sell it.

The only thing that could help in such a case is Europe-wide data security regulation. If the basic data security ordinance introduced by Viviane Reding two and a half years ago were finally enacted, then we would have the ability to go after those skirting our data protection laws in the name of competitiveness with warnings, punishments, and ultimately expulsions. Microsoft already knows this drill, and Google will soon learn it.

Digital infrastructure and digital networks are per se porous. The question is whether the gaps are so large as to allow data theft or even industrial espionage. Industry 4.0 cannot function without cloud computing, but small and medium-sized enterprises will not load their data onto the cloud until they can trust that no one can access it without their permission. For this reason Brussels has made its first attempt at a European standard for data security, the so-called Network and Information Security Directive. So far, only small member states like Malta and Cyprus have signed on – they know they are too small to protect their own data security interests. The large member states have yet to understand this.

It is also a matter of sensitivity. In Europe, we enjoy a high level of job security, as well as a sensitivity to the requirements of workplace protections. But when it comes to data, our sensitivity drops to zero. Every one of us can do more to prevent data theft. Our energy infrastructure, our traffic control centers, our airspace control: every single one of these is highly vulnerable without requiring the bodily sacrifice of a single terrorist. To avoid becoming the Achilles’ heel of our democratic, free market, liberal economies, public infrastructure will require the highest level of data security. Only a Europeanization of digital policy offers the level of defense needed in order to reestablish competitiveness with the US and South Korea. In making this happen, German industry and German politics will play an important role.

Read more in the Berlin Policy Journal App – January/February 2016 issue.

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REUTERS/Staff

Read the complete article in the Berlin Policy Journal App – January/February 2016 issue.

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REUTERS/Michaela Rehle

The notion of competitiveness currently en vogue applies business concepts such as profits and competition to countries and international trade. For firms, competitiveness is relatively simple to explain: companies compete with each other, in part on price, in part on quality and innovation. The winners of this competition make a profit, while the losers rethink their strategy – or go out of business.

False (and not so False) Analogies

For countries, almost none of this applies. Countries do not make profits. A trade surplus, often understood as a kind of national profit, is not a profit at all: First, a trade surplus simply means that a country has consumed and invested less than it has produced – some of the production was shipped abroad without a direct compensation in the form of imports. The revenue from the export surplus was thus reinvested abroad. Instead of a profit, a trade surplus simply represents a capital export. Second, by definition all trade surpluses in the world need to sum to zero, because the world as a whole cannot run a trade surplus. Treating trade surpluses as “profits” would imply that world profits are zero, which is absurd.

As for price competition, the analogy between a country and a firm is misleading. Prices matter for competition, and countries can help their export industries with an undervalued currency, for example, or by suppressing wages. But both approaches carry costs. Lowered exchange rates and suppressed wages reduce real domestic incomes and hence the economic well-being of citizens. Second, such a strategy is founded upon depressed demand at home, for which the rest of the world needs to compensate, often through unsustainable booms in consumption, investment or credit. The last few years clearly show how costly this strategy is over the medium term, for a supposedly “competitive” country. Since the early 2000s, Germany’s economy has relied increasingly on foreign demand – financed by German capital exports. It has lost almost half a trillion euros on its foreign investments since the onset of the crisis. Gaining price competitiveness is therefore not a winning strategy, and can hardly be at the core of any reasonable definition of competitiveness.

The final analogy between a country and a company concerns quality: producing better or more goods and services with fewer inputs. Economists call this productivity, and it is a well-defined and important concept. A competitive country in this sense is a productive country that manages to combine the factors of production in the most efficient way possible, thereby also creating incentives for more investment. As a result, its citizens are economically better off. To define competitiveness as productivity thus comes closer to a proper definition of the term competitiveness, as it could be applied to countries.

The World Economic Forum (WEF) defines competitiveness as “the set of institutions, policies and factors that determine the level of productivity of a country.” State institutions, labour and financial markets, infrastructure and education, and many other things interact to make a country productive, and hence competitive; and it is in all of these areas that countries need to invest both money and political effort to become more competitive.

What an Index Cannot Tell Us

An index such as the one used in the WEF’s global competitiveness report is a useful starting point for measuring competitiveness. But taking the WEF’s approach to competitiveness as a policy guideline for Europe has three important drawbacks.

First, the best mix of policies to make a country more productive may vary from country to country, even when these countries are at similar stages of development. The reason is that no country will ever have a perfectly competitive, first-best set of institutions, policies, and factors – if such a first-best even exists. Becoming more competitive therefore means changing a highly imperfect and country-specific set of institutions, rules, and constraints. In such a “second-best” world, it does not automatically follow that a policy to move towards, say, a more liberal product market automatically leads to a more productive economy. Other constraints could stand in the way, for example a lack of funding for expanding firms that could make use of more liberal product markets. In such a second-best setting, it is very difficult to determine the correct sequence of reforms, and whether they are compatible with other institutions in an economy.

The second drawback is that the macroeconomic context matters for the success of reforms, and hence their impact on productivity. The most well-intentioned structural reforms, implemented at the wrong time, can fail to generate economic growth or even make matters worse. For example, labour market liberalizations in the midst of a downturn can exacerbate a drop in demand unless exports pick up the slack. Conversely, minor structural reforms, such as Germany’s labor market overhaul in the early 2000s, can work very well if implemented just before a worldwide economic boom. This notion is particularly relevant for the eurozone: the current lack of demand requires a laser-like focus on structural reforms in areas that can immediately unleash investment without hurting demand further and thus reinforcing deflation.

Finally, improving competitiveness is not a goal, but rather a process. A country needs to constantly reassess its policies and institutions and target reforms at the most binding constraints limiting productivity growth, whatever those might be at the time. The best forum for this constant deliberation is a well-functioning, pluralist democracy.

Steps to Be Taken

Such a comprehensive concept of competitiveness would suggest certain steps in Europe as a whole and in the individual member states.

At the European level, the acute lack of demand, especially in the eurozone, makes it hard for structural reforms to pay off; the European Central Bank needs to be bolder in its monetary policy, and Europe needs to rethink its fiscal policies to ensure sufficient aggregate demand.

Moreover, companies need access to a deep pool of financing, both equity and debt, that only a Europe-wide capital market and banking system could provide. Without adequate funding, firms cannot easily invest to take advantage of newly opened markets or new innovations. Firms that grow strongly (and thereby create the most jobs) and innovative new firms often have particular trouble financing their expansion in Europe, as they lack the collateral to convince banks to fund them, and equity financing and venture capital markets are underdeveloped in Europe.

To increase productivity, European policymakers should focus on areas where a larger market size and increased competition between firms can boost investment and innovation – and thus productivity. One example would be tradable services. Here, Europe has lagged the US in terms of productivity growth for more than a decade.

Finally, the EU should agree on stronger democracy-enhancing reforms and initiatives, such as common enforceable standards for a fair and transparent justice system and support for a free and pluralistic press, areas in which the member states vary dramatically at the moment. The EU could also use its competition and consumer protection tools more aggressively to tackle national vested interests.

At the national level, European countries need to ensure that their tax systems support a meritocratic and risk-taking society. For example, taxing inherited wealth or land more strongly to finance favorable tax treatments for start-ups and proper entrepreneurial risk-taking would boost Europe’s innovative capacity. Member states should end the favorable tax treatment of debt relative to equity to encourage more innovation-friendly equity financing of firms. Tax incentives for private investment should also be stronger during a downturn to encourage investment when the economy most needs it.

In addition, states should invest more in research and development with the explicit aim of maximizing innovation Given current low interest rates and weak demand, it is also in most countries’ interests to spend more on public investment like infrastructure. In combination with other reforms, such investment would generate high returns for many European countries, particularly those that have invested very little in recent years, such as Germany.

In order to become more competitive Europe should stop using the word competitiveness; it is a nebulous concept, too vague to guide policy and easily misused by interest groups to push for policies that serve the few rather than the many. Instead, Europe should focus on productivity growth and ask how best to achieve it. The answer will be much more complex than the word competitiveness suggests.

N.B. A slightly longer version of this original article can be found on the Center for European Reform’s (CER) website.

Read more in the Berlin Policy Journal App – January/February 2016 issue.

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