Economists from the Institute for Innovation and Public Purpose (IIPP) at University College London argue in their guest article for FAS that the German state must become more innovative if we want to overcome the coming crises. The basic idea for the framework, which is based on a study prepared for the Forum New Economy, is a mission-oriented economic policy.
Germany needs a new industrial strategy
While some countries are still denying climate change, the German government is at the forefront of taking bold policy decisions with its COVID-19 recovery measures to reshape its economy towards greener, fairer and more digital economy. Doing so the government is leaving behind its neoliberal foundations which see the role of the state setting the rules of the game and leaving the rest to industry. Already before the pandemic, however, German policy makers were showing increasing appetite to go beyond simply fixing market-failures and experiment with a more openly activist state, as is evident in recently adopted Industriestrategie 2030 and Hightech Strategie 2025.
Some of this change is about finding a new narrative. As the historian Werner Abelshauser argues, German post-WWII success relied on “Ordnungspolitik der sichtbaren Hand”, the visible hand being the government support for research, development and educational institutions clustered around main industrial centres. The Energiewende was similarly driven by rapidly increasing public investments by a rather little-known German development bank, KfW. Its investments into green transition increased almost 6-fold up to 26 billion euros between 2000 to 2016. Conditions for KfW loans have had healthy conditions, such as those linked to lowering the material content for steel sector—which has helped it become one of the most innovative steel sectors in the world. This flying-under-radar industrial policy is still reflected in the tentative character of Industriestrategie 2030 and Hightech Strategie 2025.
But to move forwards, Germany needs to not only ‘do’ to talk about its industrial policy, one that is explicit about the role of the state. As Plato said, storytellers rule the world. What is the story? Critically, the narrative should not be 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.
However, the problems Germany faces are not only in narrative. One of the political corner stones of the “Ordnungspolitik der sichtbaren Hand” was the ‘deal’ to use fiscal transfers to even out income inequalities. Yet, there is increasing evidence that inequality is growing in Germany, despite increasing fiscal transfers. As shown by Cambridge economist Gabriel Palma, while Germany and South Korea have similar Gini co-efficient of disposable income, “Germany needs a relative reduction of its market Gini of 44 per cent, while Korea needs a decrease of just 9 per cent”. The link between industrial and social development is broken.
Our forthcoming paper for Forum New Economy shows that Germany has gradually evolved towards a value extractive model of capitalism. While in 1970, more than a third of German bank lending went to industry, by 2020 this has decreased to below 10%. Finance is increasingly funding non-productive investments. The financial sector is dominated by speculative finance which prioritises low-risk, short-term capital gains. This is compounded by corporate bond purchases of the European Central Bank, and by proxy also by the Bundesbank, that mirror the investment choices of financial markets and thereby have so far mostly favored large carbon-intensive companies. Policy makers should not assume that finance is neutral. We argue that 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.
Another underutilised source of funding for transformational industrial policy is procurement. Germany spends up to 500 billion euros per year through procurement. 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.
Thus, while German policy makers are increasingly embracing the idea of industrial strategy, large parts of its financial infrastructure are funding carbon lock-in and wealth extraction rather than economic transformation. 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.
To set a clear direction, Germany can make use the mission oriented approach, policies focussed on well-defined goals, that we have helped bring to the core of European Commission policy. Missions focus on solving important societal challenges, in a way you can say yes/not did you achieve it? 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. One of those questions should be: did we make the German economy more or less unequal?
High-Tech Strategy 2025 already includes 12 missions, yet they function mainly as a tool for inter-ministerial coordination of existing measures rather than bold new investments. It is very much a missions-light approach. As exemplified by the success of BioNTech, Germany is one of the leading industrial countries in the world; its industrial strategy should reflect this in its ambitions. German policy makers should use the unique window of opportunity created by the global pandemic for further institutional and policy innovations and build on recent economic policy initiatives, and successful institutions such as the KfW, and develop a bold new industrial strategy that encompasses science, technology and innovation, financial and procurement policies. Stories matter. And actions do too.