“Promoting an industry is the surest way to ruin it.” Raghuram Rajan
In the future, Biontech will concentrate its cancer research in Great Britain, Bayer will relocate its genetic engineering division to the USA, and BASF will increasingly produce basic chemicals in China and the USA. Tesla built a new car factory in Grünheide, Apple is expanding its European design center in Munich, and Intel wants to invest in a new chip factory in Magdeburg if the state funds are right. This highlights the dynamics of structural change. However, this development is not balanced. The German business model is under scrutiny. Germany is a latecomer in inter-sectoral structural change. But now the process of de-industrialization has started in Germany, more than some would like. Climate policy and the energy crisis are accelerating the development. Politicians cannot stop the decline of the “old”, often energy-intensive industries, not even with a watering can industrial policy. However, it will also not succeed in attracting “new”, future-oriented industries to Germany with subsidies in the long term. Politics assumes knowledge that it does not have. She will fail. Only a general, non-discriminatory supply policy can help. The structural change will be asynchronous in time. That will create economic, regional and social problems. Germany has a lot of catching up to do. The industrial sector is too big, the service-intensive sector too small, roughly speaking. The dilemma is: the industrial losses will materialize quickly, but the potential gains in services will only materialize with a time lag. Germany is in an awkward situation.
Basics of structural change
Structural change is omnipresent. Sometimes he’s faster, sometimes slower. companies come and go. This is normal in a functioning market economy. Promising companies prosper, less productive ones disappear. But “old” sectors, such as agriculture and industry, are also shrinking, while “new” more service-intensive sectors are growing. There are “better” and “worse” companies in the sectors. The “better” create new wealth, the “worse” shrink it. Jobs come and go with companies. They lose workers in declining companies and look for new employment in growing companies. If all goes well, labor and capital migrate (as quickly as possible) to more productive uses. Structural change is a process of “creative destruction” (Joseph A. Schumpeter). “Old” disappears, “new” emerges. However, structural change is Janus-faced. It is undoubtedly a powerful engine of economic growth and material prosperity. That is the positive side of structural change. The other, negative side of the coin is the loss of jobs, but also of human and real capital in the shrinking sectors. Especially simple work loses.
What is driving the structural change? Is it market-driven or politically driven? The answer is: He is both. On the one hand, it is market-driven because economic actors change their preferences, implement new technologies and react to changed relative prices. Demographics and digitization fall into this category. Both are primarily market-driven. With increasing prosperity, households and companies demand more services, households as end products, companies as intermediate products (here). The industrial sector loses, the service sector wins. (Worldwide) more open markets (globalization) accelerate structural change. Creeping de-industrialization is the result of growing prosperity, changing preferences and new technologies. However, there is no “optimal” industry quota. With their individual decisions, households and companies contribute to how high the industrial share is. However, political decisions do the rest. Germany is a laggard among the rich countries of the world. Its industrial sector remains larger than elsewhere. Either way, Germany is facing a process of de-industrialization, regardless of all climate policy decisions of the transformation.
Structural change is also politically driven. Politicians often set the course for structural change with regulations and subsidies. Until recently, Germany was accused of “structural mercantilism” (Martin Wolf) with wage dumping. Surpluses in the current account served as an indication. But there was no question of wage dumping. German wage policy was just more productivity-oriented than elsewhere. This, together with a weak euro, boosted the competitiveness of the industrial sector. He remained exceptionally large internationally. However, the trend has turned. An efficiency-devouring policy of decarbonization (“stupid energy policy in the world”, WSJ), the growing social aversion to innovations, but also tendencies towards de-globalization are having a severe impact on the “German business model”. With a wrong sequence of steps in energy policy – fossil energy sources are switched off before flighty renewables can be efficiently stored – and an inefficient choice of means – regulatory law instead of emissions trading – a supporting pillar of the German business model is wantonly torn down. This is also incomprehensible because it does not bring us any closer to the global 1.5% target for climate policy.
Entrepreneurs and structural change
Structural change is always a process of “creative destruction”. The old disappears, the new emerges. Scarce resources are used more productively. This helps prosperity and growth. “Creative destruction” is the “maid of economic growth” (Joseph A. Schumpeter). “Old” sectors do not disappear overnight. It is often a long process of infirmity. Economic shocks, such as energy price crises caused by wars, or political shocks, such as accelerated decarbonization policies, can accelerate the process. Ketchup effects of structural change are possible. Even “new” sectors with promising goods do not emerge overnight. New products, new processes, new organizations do not come out of nowhere. Researchers laboriously develop new things, employees invest in human capital, companies implement new things in markets. Everything together seems (sometimes) innovative. The driving force behind structural change are private entrepreneurs. They are specialists for the future, the truffle pigs of the market economy. In doing so, they often take (considerable) risks, most of the time they fail. An adequate regulatory framework for private entrepreneurship (here) reduces the risks and facilitates structural change.
How smoothly the structural change proceeds depends on how simultaneously the non-simultaneous takes place. Much would be gained if sectors were to shrink and grow at similar rates. The costs of the transformation would not be zero, however, because neither qualifications nor regions often do not fit. In the long term, prosperity increases above all when it is possible to have as many innovative companies and promising sectors as possible. This means that private entrepreneurs are crucial. If they are vital, things are going up; if they are sclerotized, it goes down. In rich countries, their vitality is increasingly being denied. They are just free riders on state-funded research and development; they acted too short-sightedly and avoided great risks; the “Sputnik” moments were missing. That would mean nothing with innovations (Mariana Mazzucato). Politicians are often the better entrepreneurs. Countries that are very active in terms of industrial policy would grow faster. This is nonsense. The real difficulty is and remains the knowledge problem. Political entrepreneurs are inferior to private ones (here). “Soft” budget restrictions, withdrawal of resources elsewhere and “rent seeking” are further weaknesses. Industrial policy continues to suffer from the MITI syndrome: it is either irrelevant or counterproductive.
Politics knows the depths of state industrial policy. This also applies to Robert Habeck, the current Economics Minister. On the one hand, he relies on bans on burners and fossil fuel heaters. On the other hand, he also knows (at least I hope) that the industrial-political knowledge problem cannot be solved politically. For that he needs private entrepreneurs. In order to motivate them to become active, politicians must create more incentives, both regulatory and monetary. This is best done in an incentive-compatible manner via a comprehensive supply policy. The “patent” on this kind of politics has (theoretically) the FDP. The Greens have little to do with it. You still have a penchant for industrial politics. They are not dissimilar to the (industry-friendly) SPD. The Economics Minister therefore came up with the idea of launching a “transformative” supply policy. In fact, his proposal is a misnomer. It is not a matter of a non-discriminatory policy that is valid for everyone, but rather a supply policy guided by a planned economy. Better supply conditions are to be created for some “promising” sectors, technologies and companies, but not for others. This kind of “supply policy”, like any controlling industrial policy, amounts to an assumption of knowledge. Subsidies pave their way.
politics and subsidies
Structural change not only creates “new things”, it also destroys “old things”. For many companies in “old” sectors, it is a struggle for survival. In doing so, they are often entitled to any state aid. Politicians also grant this help. Jobs are in jeopardy, votes are at stake. The cases are legion. A brake for industrial electricity prices is the latest variant. It is intended to give energy-intensive companies financial support until cheaper renewable energies become available. The aim is to prevent energy-intensive companies in sectors such as steel, glass and chemicals from migrating to countries with lower energy prices on a large scale. However, such a subsidy policy with the watering can will not succeed. Structural change cannot be stopped in this way. The persistently “stupid” German energy policy will keep energy prices high in this country for a long time to come. Heat pumps and e-mobility will drive demand, while the dismantling of nuclear power and coal will reduce supply. How are the prices for energy going to drop in the foreseeable future? The opposite is true. And an electricity price brake is expensive. Deadweight effects, lower investments in energy-efficient new technologies, higher burdens for citizens and other companies have an impact. The companies will take the state money and still disappear sooner or later.
This “defensive” subsidy policy is always popular. The pandemic was driving, the Ukraine war is driving on. Politicians are trying to slow down structural change. Wummse, Doppelwummse, gas cost and electricity price brakes are instruments. Structural change should be slowed down. This is different with the “offensive” subsidy policy. It is intended to accelerate structural change. One variant is based on promoting “future-oriented” technologies, companies and sectors. If successful, high pensions will be created domestically, and pensions from abroad will be diverted to Germany. However, this type of industrial policy is prone to failure: the knowledge problem has not been solved, foreign countries can hit back, there is a risk of subsidy races. The other variant of an offensive subsidy policy is climate-politically motivated. Energy-intensive, climate-damaging industries should disappear as quickly as possible. The released resources are needed for the promising sectors. This is all the more important because demographic change is producing a lack of work. The instruments of the “climate whip” are diverse. This includes emission certificates, levies and bans. Constantly rising prices for emission certificates are accelerating the structural change, albeit in a more orderly manner. Bans on technologies (oil and gas heating, combustion, nuclear power) and bids (insulation), on the other hand, are climate policy with a crowbar. Structural change is accelerated with a shock. The friction for employees and companies is correspondingly high.
The political-economic calculations of the politicians lead to a bizarre structural policy. It’s a policy of braking and accelerating at the same time. A “defensive” subsidy policy slows down structural change, while an “offensive” subsidy policy accelerates it. Energy policy illustrates the problem. For example, subsidies for heat pumps, photovoltaics and wind energy are driving sectoral structural change. The bans on fossil fuel heaters and combustion engines reinforce this development. On the other hand, gas cost and electricity price brakes preserve energy-intensive sectoral structures. They support the consumption of fossil fuels and reduce the incentives to invest in energy-efficient new technologies. The efficiency losses of braking and accelerating are considerable: The lack of openness to technology in the “offensive” subsidy policy is expensive. It creates efficiency-devouring path dependencies. The conservative, “defensive” subsidy policy also costs economic prosperity. Scarce resources are trapped in bad uses for too long. And something else becomes apparent. This type of policy encourages spirals of intervention. Politicians ban nuclear power, for example. The supply of energy is falling and prices are rising. Energy-intensive sectors are in trouble. Another intervention should help them, an industrial electricity price brake.
policies for structural change
The structural policy of the old school has the future behind it. Economic structures are constantly in flux. “Old” disappears, “new” comes. There is no point in preserving old doomed sectoral structures at any cost. This is not possible with financial or regulatory help from the state. And it is expensive, discriminates against and encourages rent seeking. Often there was nothing but expenses. However, it is also risky to rely on new sectoral structures that politicians and bureaucracy think are “promising for the future”. Non-market actors assume knowledge they do not have. Politicians and bureaucrats are not the better entrepreneurs. Both “defensive” and “offensive” industrial policies change the incentive system. They create incentives for companies to set less welfare-enhancing economic rents and to hunt for welfare-reducing political rents. What is needed is not a traditional structural policy, but a policy for structural change. The task of politics does not consist in costly industrial policy, but in efficient location policy. This is not possible without an adequate regulatory framework. A supply policy for everyone, not just for a few, as Robert Habeck’s transformative supply policy wants, is the right way.
Let structural change run its course, make the location more attractive and socially cushion friction. These are the rules of an efficient and fair policy for structural change. The nuts and bolts of a functioning structural change are open markets, nationally and worldwide. A sensible supply policy deregulates, privatizes and reduces bureaucracy at the national level. It relies on open markets as multilaterally as possible worldwide. This is the only way to succeed in using the advantages of the international division of labour. The “near- and friendshoring” of the Cold War, which has become fashionable again, is international division of labor second class. It is more important to create incentives for skilled immigration. That attracts productive talent. However, it only works in a tolerant society. There is a lack of that. And the domestic market must become more attractive for international capital again. The chances of the influx of new technologies would increase. Taxes and regulations are one thing, qualified employees are another. Better not to rely on efficiency-devouring subsidy races in national industrial policies, but on more government investment in education and basic research. A better climate for private entrepreneurship would also help. The prospect of greater prosperity would increase, but faster structural change would be unavoidable.
Structural change is no picnic, especially when existing inter-sectoral structures dissolve, as is the case at the moment. A process of de-industrialization is associated with friction. Cushioning them socially is the task of the (social) state. Labor and capital in the industrial sector are confronted with burdens. Losses of real capital are entrepreneurial risks. State aid is usually not required (here). An exception can be the protection of critical infrastructure. The situation is different with losses in human capital due to layoffs. State aid is called for here. The principle should apply here: It is not companies that should be protected, the focus should be on protecting people. It’s not about saving industrial jobs, it’s about state aid for the unemployed. The welfare state is responsible for this. Emergency help is an item. Above all, (insurance-adequate) unemployment insurance and (incentive-compatible) basic security should ensure this. Helping people to help themselves is a second element. An efficient, active labor market policy (advice, placement, qualification) is just as important as cleverly designed financial aid for flexible starting wages for the unemployed and effective promotion of (occupational, sectoral and regional) mobility.
Conclusion
A specter is haunting Germany, the specter of de-industrialization. Germany is a latecomer in inter-sectoral structural change. That’s going to change. Prosperity, demographics and digitization are driving things inexorably, high energy prices and the “world’s most stupid” (energy) policy are increasing the pace even more. “Old”, energy-intensive industries are scrapped (too) quickly. However, this does not change (almost) anything in terms of global CO2 emissions. The price that Germany has to pay is high. Sometimes one gets the impression that the traffic light policy wants to get rid of the German business model as quickly as possible. New conditions and bans that are hostile to the location are constantly plaguing him. A camouflage brake on electricity prices doesn’t help either. It is another element in an efficiency-devouring spiral of intervention. It would be better to drop the energy policy nonsense and focus on certificate trading that includes as many sectors and countries as possible. But that is not to be expected. And the next mistakes will already be made. Politicians increasingly believe that they are the better entrepreneurs. “New” promising technologies, companies and industries are singled out and subsidized. This strategy will also fail. The “transformative supply policy” is misleading. It is wrong to pursue a state-controlled supply policy that only relies on a few technologies, companies and sectors. What is needed are better, non-discriminatory framework conditions for everyone and everything, as well as incentive-compatible social protection for employees against the frictions of structural change. The inevitable process of transformation (structural change) would take place in a more regulated manner without smashing everything to pieces and secretly relying on a system change.
Podcast on the topic:
German industry under pressure. What is the right policy for structural change?
Prof. Dr. Norbert Berthold (Julius Maximilian University of Würzburg) in conversation with Prof. Dr. Oliver Holtemöller (Leibniz Institute for Economic Research Halle, Martin Luther University Halle-Wittenberg)
Blog posts on the topic:
Joachim Ragnitz (Ifo): Germany and the turning point. Promote structural change, not prevent it!
Norbert Berthold (JMU): Structural change, organizational levels and collective agreements. Are company alliances for work the future of collective bargaining?
Norbert Berthold (JMU): Structural change (1). Creative destruction everywhere!? Drivers, options and populists
