A next generation industrial strategy for Germany
By Rainer Kattel, Mariana Mazzucato, Keno Haverkamp and Josh Ryan-Collins
Germany is stepping into a new era. Its overarching economic policy framework of the past decades relied ostensibly on ordoliberal principles, which see the role of the state as making sure policy conditions enable markets to function properly. In this view, the state should fix market failures and leave the rest to industry.
However, recent strategic initiatives seek to go beyond market-fixing and lay groundworks for a more activist state. And with the handling of Covid-19, Germany has taken another step — it is now at the forefront of taking bold policy action to reshape its economy in the face of the pandemic.
Yet, its financial structure is largely still funding carbon lock-in and value extraction rather than transforming the economy to deal with 21st century challenges. Germany needs to build on its recent economic policy initiatives and develop a bold new industrial strategy that encompasses science, technology and innovation, financial and procurement policies.
Goodbye ordoliberalism?
We can trace changes to ordoliberal principles to the mostly successful Energiewende (energy transition) policies during the 2000s. Rather than providing just the policy framework for the market to achieve greater use of renewables, the German state embarked on the bold mission of the Energiewende. Through the use of feed-in tariffs and the provision of subsidised long-term finance via Kreditantstalt für Wiederaufbau (KfW), Germany’s state development bank, Germany has since the late 1990s created domestic demand to promote the use of renewable energies. Figure 1 shows the dramatic increase of investments by KfW into environmental and climate protection since 2000.
Figure 1. KfW’s domestic total and investments in environmental and climate protection (in €bn)
Energiewende arguably created a global market for solar panels and lead to increased innovation and investment into the green transition. By 2014, German businesses provided circa 50 per cent of all European corporate investments into energy-related R&D. The Energiewende can be described as a successful case where mission- and diffusion-oriented elements of innovation policy were combined. The cooperation between different ministries and the state investment bank KfW provided a reliable institutional setting for mission-oriented policies and investments. The KfW remains, however, largely unknown in German political debates and the Energiewende is often seen as quite unsuccessful.
Until very recently Energiewende was the exception rather than the rule in German economic policy that has been characterised by more diffusion-oriented policies aligned with ordoliberal principles. This has started to change in the last couple of years. First, Industriestrategie 2030, introduced in 2019, is carried by the sense of geopolitical urgency and the need to protect German industrial companies from foreign takeovers. Yet, the strategy explicitly relies on ordoliberal principles.
Second, in 2018, the German government introduced a framework policy agenda called High-Tech Strategy 2025, which acts an an overall coordination strategy for German science, technology and innovation policy. Its aim, together with the federal states and the private sector, is to increase R&D spending to 3.5 per cent of the gross domestic product. And while the strategy includes 12 missions, it functions mainly as an inter-ministerial coordination instrument in order to provide better alignment between the existing, largely diffusion-oriented science, technology and innovation policies and industrial landscape, and socio-economic challenges. It is very much a ‘missions-light’ approach.
A new approach after COVID-19
The response to COVID-19 has galvanised discussions of German economic policy to rethink some of its foundations. While in the 2010s, the German response to the financial and fiscal crisis was largely defined by austerity and supporting existing industrial practices such as scrappage support for old cars (Abwrackprämie), this time the government has taken a bolder sustainable approach in its support measures published on June 3rd, 2020.
Since the beginning of the pandemic in 2020, the German government has committed 50 billion euros to support different energy types through 18 new or amended policies. Figure 2 shows, compared to other G20 countries, Germany has committed the most to clean energy (both conditional and unconditional) with a total of 24 billion euros.
Figure 2: COVID-19 recovery packages from a climate and energy perspective
In addition, while many countries are lending to companies with no strings attached, Germany is proposing to take ownership stakes in ailing companies, an idea that seems to enjoy wide support among leading domestic economists.
While there are signs of a changing economic consensus, the collective political mindset seems to be about catching up with leading economies rather than being a leading economy. Indeed, in some respects Germany is falling behind. Its share of patents in future technologies is falling. The oft-praised Energiewende seems to be stuck in a multitude of support programmes and lack of policy coordination.
A market shaping policy framework
In a forthcoming paper for the Forum for a New Economy, we argue that German policy makers should use the unique window of opportunity created by the global pandemic for further institutional and policy innovations for more directed investments by both the public and private sectors. This should involve a new economic policy model that explicitly aims to shape markets for more sustainable and equitable growth.
Through well-defined goals, or more specifically ‘missions’, that are focused on solving important societal challenges, policymakers have the opportunity to determine the direction of growth by making strategic investments, coordinating actions across many different sectors, and nurturing new industrial landscapes that the private sector can develop further. The result would be an increase in cross-sectoral learning and macroeconomic stability.
Such challenge-led and market-shaping approach is not about top-down planning by an overbearing state; it is about providing a direction for growth, increasing business expectations about future growth areas, and catalysing activity — self-discovery by firms — that otherwise would not happen. It is not about de-risking and levelling the playing field, nor about supporting more competitive sectors over less, since the market does not always know best, but about tilting the playing field in the direction of the desired societal goals, such as the climate emergency.
Similarly, it is not about ‘more state’ or ‘less state’, but a different type of state. One that is able to act as an investor of first resort, catalysing new types of growth, and in so doing crowd in private sector investment and innovation which represent expectations about future growth areas. This requires a new form of collaboration between state and business — more about picking the willing than picking winners.
Financing the transition
The structure of the financial system is key to achieving this goal. In particular, there is an essential difference between types of finance that are conducive for investment in the real economy and speculative finance which prioritises low-risk, short-term capital gains through the trade of existing assets. As shown on Figure 3, German financial sector is decreasingly funding the manufacturing sector.
Figure 3: Share of bank lending in Germany by industry sector, 1970–2020
This shows how vital public funding of industrial transition through KfW is. Going forward, it is essential that the KfW continues to provide long-term, patient finance, which is willing to take risks and able to mobilise and crowd in other investors.
However, an area that has received less attention is the role of central banks and financial regulators in addressing climate-related financial risks. Since the Global Financial Crisis of 2008, central banks have increasingly used a wider range of ‘unconventional’ measures, including quantitative easing and various other short and longer-term liquidity programmes to stimulate the economy. The expansion of central bank interventions into markets presents an excellent opportunity to re-channel financial flows more strategically towards greener, zero-carbon alternatives. Despite this large potential, research suggests that corporate bond purchases of the ECB mirror the investment choices of financial markets and thereby have so far mostly favoured large carbon-intensive companies. To prevent this undesired consequence, central banks should either recalibrate quantitative easing purchases to exclude carbon-intensive financial assets or run a parallel green quantitative easing programme to mitigate the effect.
However, given that the Bundesbank executes the quantitative easing programme on behalf of the ECB, the de facto power of the Bundesbank is relatively small. Nevertheless, Germany’s influence on the ECB is significant. At the very least, it would seem appropriate for the Bundesbank to actively review its asset purchase criteria to examine the extent to which climate-related financial risks are properly integrated in its collateral and asset-purchase programmes.
The financial structure in Germany is thus largely funding carbon lock-in and wealth extraction rather than economic transformation.
Strategic procurement
Another underutilised source of funding and changing both lifestyles and industrial production is procurement. Public authorities in the EU spend around 2 trillion euros each year on these purchases, which amounts to 14 per cent of GDP; Germany alone spends up to 500 billion euros through procurement. Given this enormous purchasing power, green or sustainable procurement holds large potential to decarbonise the economy. In contrast to emission trading schemes, with prices too low to effect a low-carbon transition, green procurement offers a significant and immediate way forward. As a positive spill-over effect, green procurement has the potential to initiate the development of lead-markets for climate-friendly technologies and provide incentives for green innovation.
Germany procurement laws enable public authorities to include strategic goals, such as environmental requirements, in the award criteria of the bidding process. However , only 2.4 per cent of all public contracts awarded in 2015 in Germany included environmental criteria for public procurement. While Germany has formulated ambitious decarbonization goals at the federal level, this does not seem to be matched at the state and local level where a number of challenges and barriers remain to green procurement practices.
Conclusion
Markets will not find a green and inclusive direction for innovations on their own. Germany’s innovation, industrial, financial, and procurement policies must therefore complement each other and go beyond independent initiatives and discrete approaches.
Only when there is a stable and consistent direction for investment will regulation and innovation converge along a green and inclusive trajectory. The government cannot micromanage this process, as that would stifle innovation. But it can set a clear direction, make the initial high-risk bold investments which attract private actors later on, and reward those who are willing to invest and innovate.
