Frankfurt’s financial giants have had a rough start to the year. After several years of steady growth, the German economy has begun to show signs of weakness. Exports, the basis for Germany’s economic muscle since the end of World War II, have fallen since the end of 2018. The trade surplus, which is another indicator of Germany’s economic health, shrunk for the first time this decade. Uncertainty surrounding Brexit, rising protectionism and trade tensions with China have placed a damper on the expectations of Germany’s leading exporters. Business confidence among German exporters has also taken a hit amid expectations of a slowdown in the global economy.
Despite these external challenges to the economy, Germany’s macroeconomic fundamentals remain strong. The country boasts an educated workforce and some of Europe’s finest technical institutes. German businesses benefit from a strong legal framework and extensive infrastructure. Unemployment remains low and inflation is under control. However, in the long run, Germany must reinvent itself to remain a dynamic economy. In light of trends shaping the global economy, German policymakers need to rethink their approach to an iconic German industry: technology.
Germany has given the world more than its fair share of brilliant scientists and engineers. Household names like Daimler AG, BMW, Siemens and SAP all call southern Germany home. Although Germany’s industrial might and technical expertise remain unquestionably strong, the country’s startup scene looks feeble in comparison. In 2017, venture capital investment in the United States soared to $84 billion. In the same year, venture capital investment across Europe amounted to a comparatively puny $17 billion. Entrepreneurs complain that German culture lacks an entrepreneurial spirit and that investors take too few risks, preferring to invest in proven technologies. Fear of uncertainty extends beyond institutional investors. Only one in 10 Germans own stocks or equity funds since most choose to invest in securities such as bonds with guaranteed, albeit much lower, returns. Many of Berlin’s top technology companies are actually copycats of successful American ones and rarely stray beyond the realm of online services. A preference for incremental innovation has transformed the country into a leader in advanced technologies but deprived it of cutting-edge technology companies.
German investors need to develop a greater appetite for risk before Germany becomes known for disruptive, cutting-edge tech innovation. Currently, startups with proven business models attract capital at much higher rates and in much higher quantities than those with potentially disruptive products. Tech startups in e-commerce, a well-established industry with a mature American counterpart, soaked up a third of all venture capital financing in 2015. The founders of Zalando, arguably Germany’s most successful tech startup, took liberal inspiration from American company Zappos to build a fashion e-commerce empire. The allure of eye-popping margins in the online services industry attracts the lion’s share of Germany’s cautious venture capitalists and angel investors. Compared to Internet startups, technology startups with physical products, which are often much more complex and expensive, strike far fewer startup funding deals. The substantially higher cost of prototyping and producing a physical product deter already hesitant investors. In a list of the top 100 most innovative German tech start-ups published by Forbes, only one produces hardware. The lack of adequately funded hardware startups will place Germany at a disadvantage, as other countries race to develop advanced capabilities in virtual reality, robotics and supercomputing.
Germany’s aversion to risk contributed to the global dominance of American technology companies like Amazon, Apple and Microsoft. For decades, Germans have preferred to play the part of fast follower by leveraging their country’s skilled workforce to imitate successful American business models. Although one startup is founded every 20 minutes in Berlin, breakthrough innovation continues to take place in America. This dynamic, however, is about to be disrupted. In recent years, innovation in China has received a big boost from state funding. However, concerns over the integrity of Chinese hardware have grown after the United States implicated companies like Huawei in espionage on behalf of Chinese intelligence agencies. Given the broad reach of the state in China, many fear that the Chinese government could ask its companies operating in Europe to create backdoors in their technologies that would allow it to spy on European targets.
The decentralization of innovation away from Silicon Valley increases the threat to Germany, and more broadly Europe, of continuing to rely solely on a trusted ally such as the United States for innovative breakthroughs. Despite continued allegations of espionage, Huawei, rather than an American company, has shown global leadership in 5G wireless networks, a technology that will vastly improve Internet connectivity. To insure itself against the emerging technology rivalry between the U.S. and China, Germany must work with the EU to make more funding available to startups with the potential for disruption. The EU currently allocates the majority of its budget towards job creation with the aim of reducing economic inequality among member states. Much of this money is made available to small businesses through grants and loans. However, tech startups require more attention and nurturing than most small businesses. The EU and the German government should allocate a share of these funds towards the creation of incubators and accelerators that focus on hardware startups with fresh ideas. Precedence exists for large-scale government involvement in nurturing breakthrough technologies; Silicon Valley has its roots in an early effort by the government to create a decentralized communication network that we now call “the Internet.”
The slogan of Lexus, the luxury car division of Toyota, is “The Pursuit of Perfection.” Despite its Japanese origin, the slogan embodies both best of the German engineering spirit and its limits. Bavaria, the same region that hosts Oktoberfest, is home to companies like Siemens and BMW that follow the mantra of incremental innovation. While this works well in the mature industries for which Germany has built a formidable reputation, it fares poorly in an industry where “Move Fast and Break Things” has become the norm. The growing threat to information security from China imbues Germany’s startups with unique significance from a national security perspective. With the right framework and policies, Germany can contribute to the digital economy and make Europe a safer, more dynamic place.
Categories: Foreign Affairs