‘Organised capitalism’ and an ‘interventionist state’ were key elements of Imperial Germany’s rapid economic development after 1871 (Hentschel 1978). In combination with post-unification economic integration and French war reparation, this helped turn Germany into a successful ‘late developer’ (Gerschenkron 1962). Economic policy under the Weimar Republic (1919-1933) was primarily concerned with restoring stability in the wake of hyper-inflation and then again following the New York stock market crash and the onset of the world economic crisis. The years 1933-45 saw increasing state intervention and, especially after 1942, a full-on shift towards a centrally coordinated war economy (Toooze 2006).
The Federal Republic adopted the so-called social market economy model based ordo-liberal principles (whose intellectual progenitor was the Freiburg School), while the German Democratic Republic adopted a system of planned economy (in German: Zentralverwaltungswirtschaft!). The social market economy model was based on free market principles underpinned by macro-stability, a stable, predictable institutional framework (think: Bundesbank) and social welfare policies. Unlike many other countries in East and West, West Germany did not engage in economic planning and largely refrained from interventionist, industrial policies, with some notable exceptions (e.g. Airbus), or at least used it more sparingly than many other countries. Even its attempt at Keynesian demand management in the late sixties proved short-lived (Scharpf 1987, Katzenstein 1987).
Recently Germany has begun to shift towards a more activist industrial policy. Some analysts have voiced fear about the rise of economic nationalism (Zettelmeyer 2019). The shift towards a more activist economic policy, away from long-standing ordo-liberal principles, marks a notable change and need to be largely understood as a response to China’s economic emergence and in particular the challenge China’s state-capitalist model poses to advanced economies in general and Germany in particular.
The acquisition of German robotics makers Kuka by a Chinese conglomerate in 2017 seems to have been a watershed moment. Germany soon passed new legislation, significantly tightening rules on inward investment and foreign acquisitions. It also threw its support behind an EU-wide FDI screening mechanism and it considered setting up a state-backed fund to fight off foreign acquisition in sectors deemed strategically important. (The recent epidemic has given further impetus to state involvement in the economy through the acquisition of equity stakes, not to mention the socialisation of private-sector financial risk.) Most significantly, Germany has also adopted a comprehensive national industrial policy strategy called Nationale Industriestrategie 2030.
As part of its national industrial strategy, Berlin is also rethinking its approach to economic openness as far as foreign (non-EU) investment is concerned. Germany's rethink and newfound fondness for industrial policy is to a large extent driven by China. German concerns range from the (alleged and actual) non-market behaviour and increasing acquisitiveness of Chinese companies to complaints about a lack of reciprocal market access. Ultimately the biggest concern is about German competitiveness in the face of a rapidly modernising China. Hitherto Germany has benefitted more from China’s rapid industrialization than all other major economies given China’s seemingly insatiable demand for capital goods.
With China gradually shifting into advanced economic sectors, parts of the German industrial base are set to face increasing competition. As part of a concerted national effort called Made in China 2025, the Chinese government is seen as relying on non-market instruments to build an advanced indigenous technological base through forced technology transfer, competition and market access policies, (sometimes) outright IPR theft and, of course, foreign acquisitions carried about by state-owned/ -supported companies. Given Germany’s considerable trade with China, Berlin is seeking to address this challenge through a mixture of tightening investment restrictions and industrial policy, rather than trade measures. (Moreover, trade policy falls under EU jurisdiction.) Concerns about the politicisation of international economic interdependence (Jaeger 2020) are at best a secondary concern at the moment, compared to the perceived threat to German technological leadership in key economic sectors.
With China gradually shifting into advanced economic sectors, parts of the German industrial base are set to face increasing competition. As part of a concerted national effort called Made in China 2025, the Chinese government is seen as relying on non-market instruments to build an advanced indigenous technological base through forced technology transfer, competition and market access policies, (sometimes) outright IPR theft and, of course, foreign acquisitions carried about by state-owned/ -supported companies. Given Germany’s considerable trade with China, Berlin is seeking to address this challenge through a mixture of tightening investment restrictions and industrial policy, rather than trade measures. (Moreover, trade policy falls under EU jurisdiction.) Concerns about the politicisation of international economic interdependence (Jaeger 2020) are at best a secondary concern at the moment, compared to the perceived threat to German technological leadership in key economic sectors.
Some analysts have pointed out that China’s IPR record is improving (Lardy 2018, Huang 2019). But this will be of little consolation to the technological leader economies concerned about retaining their edge, not least because China's long-standing 'Going abroad' policy also allow China to acquire technology, not infrequently thanks to state support. It is certainly reasonable to expect China to become increasingly compliant with global IPR standards as it becomes a producer of net innovation instead of being a net consumer of it. Then again, having benefitted from it, China was to become a ‘responsible stakeholder’ in the international system (Ikenberry 2007). This does not seem to be panning out (CFR 2015, Brookings 2020)
It looks at least equally likely that China’s compliance with IPR rules will remain selective, especially given intensifying Sino-US security competition. And there is always the possibility that China will comply with IPR rules in sectors of lesser strategic significance, while flaunting the rules in more strategic areas. The recent tightening of inward investment rules in a number of advanced economies (Australia, EU, Japan, US), including Germany, and more vocal demands on China to reform its IPR , technology transfer, market access and SOE policies need to be seen in this light: concerns about a level playing field and, ultimately, concerns about increasing Chinese competition. It is of course true that ‘catch-up’ economies often engage in IPR theft, patent violations or at very least reverse engineering (Huang 2019). Politically, however, this does little to appease advanced economies or lessen their economic-political concerns.
The most technologically advanced economies all share similar concerns about the Chinese government's concerted efforts to develop emerging technologies, such as AI, robotics, big data, nano-technology etc. As part of Made in China 2025, Beijing is pursuing a broader, focused national industrial policy aimed at making China a 'leading manufacturing power by 2049'. Unlike Washington, Berlin is less concerned about the military potential of these technologies than about how they may affect its technological-economic position. It is one thing to “trade" low value-added sectors for access to a rapidly growing market for high value-added capital goods. It is another matter entirely to push for (or maintain) economic openness or stick to laissez-faire economic policies if it risks the erosion of one’s technological leadership position.
This is all the more of a concern to the extent these new technologies are seen, rightly or wrongly, as being characterised by winner-takes-all competition (Lee 2018). If this is in fact what they are, then the stand-off over foreign investment rules and national industrial policies is akin to a classic issue in strategic trade theory (Brander-Spencer model), where state support can help a national champion ‘defeat’ its competitor under conditions of a duopoly and subsequently appropriate significant rents. In international trade, the infant industry argument (Friedrich List, JS Mill) has a similar logic. Note however that the veracity of this argument in favor of state intervention critically depends on the assumption that these technologies are characterised by winner-take-all outcomes and that the laggards cannot reverse-engineer these technologies, or can only do so at great cost and with considerable difficulty.
Standard economic theory posits technological diffusion and economic efficiency, while political economists poinst to the inextricable link between 'power and plenty' (Viner 1948). Political-economy scholars see national economies as competing with other economies, economically and politically, and are less interested in and less concerned with allocational efficiency than economists. If international economic exchange is seen as though the prism of competition rather than efficiency maximisation, retaining technological leadership becomes important. And under condition of imperfect markets, rents will accrue to the 'winner'. If emerging technologies are characterised by winner-take-all competition and generate significant spill-over effects in the national economy and if government-led industrial policy makes it significantly more likely to master these technologies (Brookings 2020), then the advanced economies cannot sit by idly. Critics of industrial policy often point out that state-supported policies are not significantly more likely to lead to success than innovation that relies on market forces – at least if the comparison is between China and the US. It is also not clear whether the emerging technologies are truly winner-take-all technologies. The latter is difficult to evaluate. With respect to the former, there is historical experience.
Industrial policy remains surprisingly controversial among economists and political economists alike (Johnson 1982, Wade 1990, Woo-Cummings 1999, Chang 2002). While most scholars would agree that successful economic ‘catch up’ took place against the backdrop of state-supported development policies, it is also true that many attempts at state-led economic development ended in relative failure. Germany, Japan, Korea and, today, China were very successful as so-called ‘latecomers’ relying on state-led policies. Other cases were less successful, if perhaps not entirely unsuccessful (e.g. Brazil, Mexico, Turkey) depending on what one's benchmark for success is (Rodrik 2008). And the World Bank (1993) controversially attributed East Asia’s economic rise to liberal rather than state-led policies. While there are good theoretical arguments why government industrial policy can help foster economic growth and development (Rosenstein-Rodan 1943, Scitovsky 1954), the evidence does suggest that industrial policy needs to be deployed intelligently and cautiously if it is to be successful. Simply put, it is no panacea.
Historically, successful industrial policy has depended on (a) support of domestic producers in sophisticated industries, (b) export orientation and (c) pursuit of fierce composition with strict accountability (IMF 2019). Policy should focus on (relative to the level of development) advanced sectors rather than declining ones. Export-oriented industries promise higher returns per unit of government support. Incentives need to be well-designed, capture by rent-seeking must be steadfastly avoided, and the beneficiaries of government support must be held accountable. After all, industrial policy – more so many other types of economic policy – tends to provide significant incentives for rent-seeking (Tullock 1967). And it is always a fine line that divides ensuring the existence of a level playing field (fair competition, fair trade and so on) and offering efficiency-reducing rents to special interests.
The notion of a national (European) champion illustrates the potentially two-edged nature of industrial policy. On the one hand, economies of scale may be necessary to withstand extra-regional competition (e.g. Chinese train manufacturers) and preserve an indigenous economic base. On the other hand, a domestic quasi-monopoly may weigh on efficiency and weaken the incentives to increase productivity and innovate. Interestingly, European competition policy has been quite successful in efficiency terms, compared to the US (Philippon 2019). But this may also part of the reason why the US has more global players with sufficient scale, perhaps in part thanks to their unassailable domestic market position (Google, Apple, Facebook).
Rent-seeking interests represent a constant threat to a successful industrial policy. There is a ready political market for rents. Preserving jobs is not too difficult to sell to elected politicians and subsidies are perfectly well-suited for successful rent-seeking because they are typically highly targeted and specific (Olson 1964). There is a legitimate concern about preserving robust national economic capabilities in strategically important sectors (as the recent debate about 'just-in-case' versus 'just-in-time' supply management demonstrates). But there must also a genuine concern about industrial policies being undermined by political-electoral opportunism and rent-seeking interests. This is a difficult balance to be struck and policymakers would be well-advised to recognise that the successes of industrial policy are about as numerous as the failures. Nonetheless, if creating a level playing field remains elusive and/ or maintaining technological leadership is regarded as quasi-existential, an intelligently designed government policy that supports innovation and productivity in strategic economic sectors represents a (second-best) solution.
The strategic concerns underpinning Germany’s newfound fondness for national industrial policy are well-understood. The emergence of China not only as an economic competitor but as a large economy whose government has successfully put substantial resources behind comprehensive and long-term national development strategies in the past and is prepared to resort to non-market behaviour has advanced economies concerned - and especially those with a large and sophisticated industrial base. However, in order for industrial policy to be successful, it needs to be well-designed and impose strict accountability. The strategic reasoning behind industrial policy is defensible given the uncertainty related to the potential benefits and winner-take-all characteristics of emerging technologies and the way they might impact 'national competitiveness' (pace, Paul Krugman 1994), or (national) productivity. The conceptual design and practical implementation of industrial policy is tricky. Last not not least, it is worth remembering that industrial policies focused on 'catch up' economic development are easier to implement successfully than a national industrial strategy at the technological frontier. Both Berlin and Beijing would be well-advised to bear this in mind. Food for (further) thought.