What if Germany stopped making cars?

“THE FUTURE of the VW brand is at stake.” When Thomas Schäfer, the mass-market marque’s newish boss, gave a presentation to his management team in early July, he did not sugarcoat its problems. High costs, falling demand, growing competition—the list goes on. “The roof is on fire,” he warned, echoing one of the most noted alarm calls in recent business history—from Stephen Elop, who in 2011 compared his company to a “burning platform” shortly after taking the helm at Nokia, then the world’s largest maker of mobile phones.

In the case of Nokia, the wake-up call did not help. A few years later the firm was dismantled and its mobile-phone business sold to Microsoft, which has since closed it down. Could mighty VW, its mightier parent group, which owns nine other brands, or even Germany’s mightiest industry as a whole really suffer a similar fate? And if it did, what would that mean for Europe’s biggest economy?

An imminent implosion of the car industry seems unlikely. In 2022 Volkswagen was the world’s largest carmaker by revenue, giving it plenty of cash to support its biggest brand. On July 27th it reported that sales rose by a healthy 18% in the first half of 2023, year on year, to €156bn ($174bn). BMW and Mercedes-Benz, Germany’s two other big automotive concerns, are in decent nick.

Yet disaster is no longer inconceivable. German industrialists are feeling real angst about the future. In July an index of business confidence from Ifo Institute, a think-tank, fell for the third consecutive month. German bosses echo Mr Schäfer’s list of concerns and add other gripes, from bunged-up bureaucracy to the delicate geopolitics of trade with China.

Carmakers are more exposed to these challenges than most industries, as they are having to negotiate several transformations at once. They must electrify their fleet, for instance, and learn to develop software. As these trends play out, more of the value added is likely to come from elsewhere. Industry insiders admit that factories will have to shrink or even close down, as will many suppliers, especially those which make parts for internal combustion engines and gearboxes.

Germany’s car industry must also tackle its growing China problem. Having benefited from the Asian giant’s rapid growth in recent decades—in the second half of 2022 Germany’s three big car companies made around 40% of their revenue there—they are now suffering from a reversal of fortunes. Volkswagen has just cut its global delivery forecast owing chiefly to slowing Chinese sales. Geopolitics are liable to make things worse. And Chinese rivals have started expanding abroad, particularly in Europe. Last year, for the first time, China exported more cars than Germany: around 3m and 2.6m vehicles, respectively.

Driven to extinction?

All these problems are coming together in Wolfsburg, home to Volkswagen’s headquarters—and thus the roof in Mr Schäfer’s metaphor. According to press reports, orders for the group’s EVs are between 30% and 70% below plans, depending on the marque. The firm still has to sort out its software problems: in May it again shook up the management team of Cariad, its digital unit. In China’s fast-growing market for EVs, the VW brand is an also-ran, with a market share of 2%.

The consequences of carmakers’ potential demise depend on how big you think the industry is. Carmaking directly employs fewer than 900,000 people in Germany, two-thirds of them at the car firms and the rest at their suppliers. That is just 2% or so of Germany’s total workforce. Nearly three-quarters of passenger cars sold under a German brand are now made abroad. Last year a mere 3.5m vehicles left local factories—about as many as in the mid-1970s.

Worried industry insiders point to alternative measures. More than half of the EU’s carmaking gross value added is produced in Germany, miles ahead of France, which is second with 9%. Cars account for 16% of German exports of goods. And although the economic importance of Germany’s car industry peaked at 4.7% of the country’s gross value added in 2017, the share was still at 3.8% in 2020, the last year for which data are available, calculates Nils Jannsen of the Kiel Institute, a think-tank. According to other estimates, this is about a percentage point more than other carmaking powerhouses such as Japan and South Korea.

Moreover, zeroing in on narrow industry numbers misses the sector’s true importance for Deutschland AG. “It’s an operating system of sorts,” explains Oliver Falck, who runs the Ifo Centre for Industrial Organisation and New Technologies. “Important parts of the German economy and its institutions rely on it,” he says.

For starters, direct suppliers are not the only ones to depend on Volkswagen and its peers. More recent numbers are hard to come by, but according to a study in 2020 by Thomas Puls of IW, another think-tank, and others, global demand for German cars accounted for more than 16% of the value added of Germany’s metal bashers and plastics makers. They also estimated that such global demand indirectly paid for another 1.6m jobs, bringing the total number of people supported by the car industry to 2.5m, more than 5% of the German workforce.

German investment and innovation are tied to the country’s carmakers. The car industry accounted for 35% of gross fixed capital formation in manufacturing in 2020, according to IW. In 2021 the sector was the source of more than 42% of manufacturing research and development and paid for 64% of all R&D conducted by other firms and research institutions, based on numbers from the Stifterverband, an association mostly of research foundations. According to IW, carmakers accounted for nearly half of corporate patent filings in 2017, up from a third in 2005.

The car industry is also central to Germany’s much-vaunted social model. One important element is regional equality. Car factories were often built in otherwise economically weak areas, of which Wolfsburg is the prime example. The sector shores up many of these regions. According to one recent study, 48 of Germany’s 400 cities and counties are heavily dependent on jobs in the car industry. Wolfsburg leads the pack: 47% of the city’s workers toil in the sector. Should carmaking fade, Germany would face “many local crises”, says Wolfgang Schroeder, one of the authors of the study and a fellow at the WZB, a research outfit.

Without a strong car industry, Germany’s generally placid industrial relations would become much rougher. Union leaders such as Roman Zitzelsberger, who heads IG Metall in Baden-Württemberg, the state that is home to Mercedes-Benz, Porsche and Bosch, a giant car-parts supplier, freely admit that it is the organisation’s “backbone”. IG Metall’s some 2m members make it the world’s single biggest trade union. About a third of them work in the car industry. Union membership at some companies in the sector reaches 90%. This strength, in turn, helps IG Metall negotiate good wage deals which then radiate out to other firms and industries where it is less entrenched.

The car industry also undergirds Germany’s model of co-determination, where workers are guaranteed representation on corporate boards. Volkswagen is again the prime example. The sector’s powerful works councils provide IG Metall with access to important resources, from money to information. Employee representatives make up half the firm’s 20-member supervisory board, giving them access to regular updates about the company’s condition and the ability to veto strategic decisions. (Another two members are political appointees from the state of Lower Saxony, which owns 12% of the group.)

If this arrangement were to fall apart, it would alter the balance of Germany’s labour market, reckons Sebastian Dullien, an economist at the Hans-Böckler-Stiftung, a trade-union think-tank. “To exaggerate only a bit, it will make a big difference whether Volkswagen manages its transformation or whether it is replaced by Tesla,” he says, referring to the American EV pioneer, which has just announced that it intends to expand its plant near Berlin to what will be Europe’s biggest car factory. Over time, says Mr Dullien, manufacturing jobs in Germany would no longer be exceptionally well paid relative to service ones and manufacturing jobs in other European countries.

Harder to measure, but no less profound, would be the psychological effects of a diminished German car industry. The reputation of German industry and its engineering prowess, already knocked by Volkswagen’s “Dieselgate” emissions-cheating scandal of 2015, would take another hit. In a paper published last year, Rüdiger Bachmann of the University of Notre Dame and others calculated that because the company was found fiddling with emissions readings, sales of other German brands in America fell by 166,000 cars, costing them $7.7bn in forgone revenues, or nearly a quarter of their total in 2014.

If Germany’s car industry were to evaporate, in other words, this would “leave a huge economic crater in the midst of Europe”, says Mr Schroeder of WZB. Germany’s politicians are, of course, desperate not to let that happen. After Dieselgate, their support for the sector is less wholehearted. But subsidies such as tax breaks for company cars, which make it worthwhile for employees to forgo a part of their salary in exchange for a high-end vehicle, are not going away. More than two in three new cars in Germany are bought by companies; many end up being driven mostly on personal trips.

In Lower Saxony the car industry may well be too big to let fail. Volkswagen operates factories in five places besides Wolfsburg. Altogether, the firm employs about 130,000 people there. The state’s politicians need only look next-door at Thuringia to see what might happen if its economy floundered—which it inevitably would were Volkswagen to crumble. The far-right Alternative for Germany party now leads Thuringian polls with 34%.

Riding into the sunset

Such considerations are drowning out voices pointing out that extending life support for carmakers could be counterproductive in the long term. Mr Bachmann thinks German politicians need to put a bit more faith in market forces to fill the economic space that might open up as German carmaking wanes. Germany’s oversized car industry, once a strength, increasingly holds the country back, argues Christoph Bornschein of TLGG, a consultancy. “Cars are the biggest manifestation of Germany’s total focus on mechanical engineering,” he says. As Volkswagen’s ongoing problems with its software unit show, an economic system that is optimised to churn out expensive mechanical wonders that run like clockwork will struggle to reinvent itself in an increasingly digitised world.

Once the car industry is no longer that dominant, there would be more space for alternatives. Fewer subsidies would flow into the sector, and more capital into startups. Fewer young Germans would study mechanical engineering and more opt for computer science instead. And researchers would put more effort into, say, developing mobility services instead of filing one more car-related patent.

The freewheeling approach has worked for Eindhoven. The Dutch city, once as dominated by Philips, a one-time electronics giant, as Wolfsburg is by Volkswagen, now hosts thousands of small companies. Most of these supply ASML, a manufacturer of advanced chipmaking equipment that has emerged as one of Europe’s most valuable companies. Espoo, still home to the rump Nokia, which today makes telecoms networking gear, also now boasts a thriving startup ecosystem.

Admittedly, carmaking is much more deeply rooted than the ephemeral production of electronics such as mobile phones. As such, especially if the decline is gradual, the sector will adapt. Big suppliers such as Bosch or Continental will work more for foreign carmakers such as Tesla (in the Californian firm’s early days, Bosch is said to have provided 80% of its value added). Smaller suppliers will specialise and provide services, as many Mittelstand firms have done before. And Germany is likely to stop producing cheaper cars and focusing even more on making smaller numbers of higher-margin luxury ones. Volkswagen may even turn itself into a contract manufacturer, assembling EVs for other brands, much as Foxconn puts together iPhones for Apple.

Some in and around the industry are already imagining a future without Volkswagen, at least as it exists today. The business “needs to stop building its strategies only around the car”, says Andreas Boes of ISF Munich, another research outfit. Mr Boes leads a group of youngish car-industry executives and experts which recently published a “Mobilistic Manifesto”. Instead of making cars ever more comfortable, so people spend more time in them and can be sold additional services, firms should aim to organise society’s ability to go from A to B as a whole, he suggests. Volkswagen and its fellow German carmakers have always helped people move around. There is no reason why they shouldn’t keep doing it in clever new ways.

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https://www.economist.com/business/2023/07/31/what-if-germany-stopped-making-cars What if Germany stopped making cars?

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