Foreign Investors Flock to Europe’s Economic Motor

BY CATHERINE BOLGAR

Most countries have made a choice: Go for high-tech, knowledge-driven sectors but abandon manufacturing, or else be a manufacturer and exporter but keep costs low.

Germany has the best of both worlds. It’s a high-tech, knowledge-driven powerhouse of manufacturing and exporting.

“Germany is famous for well-engineered, innovative products,” says Michael Pfeiffer, chief executive of Germany Trade & Invest, the country’s foreign trade and investment promotion agency, based in Berlin and Cologne. “We offer products at competitive costs — which doesn’t mean we’re the cheapest. It’s a combination of efficiency and innovation. That’s what makes Germany interesting for foreign investors.”

Highly Competitive

Germany is consistently among the top 10 in the World Economic Forum’s Global Competitiveness Index, ranking No. 5 out of 139 countries for 2010-2011. It helps explain why foreign direct investment inflows to Germany increased more than 45% in 2009, when, worldwide, they fell 37% from the year before, according to the United Nations Conference on Trade and Development. Germany’s FDI inflows for 2009 ranked No. 7 worldwide.

Another factor is that investors like a sure thing. The economic recovery looks shaky in much of the world, but Germany posted a 2.2% quarterly growth rate in gross domestic product for the second quarter, equivalent to 9% on an annualized basis — a rate that’s more akin to developing nations like China than to established economies. And exports rose 8.2% in the same quarter.

“Germany’s economy is still surprisingly strong at the moment,” says Felix Huefner, senior economist for the Organization for Economic Cooperation and Development (OECD) in Paris, who is responsible for Germany and the Slovak Republic. While most economists, including those at the OECD, expect the red-hot growth rates to ease, “underlying fundamentals are quite strong,” he says.

Germany’s decision not to further extend stimulus spending and shift to budget tightening measures is being closely watched, with some economists arguing the move came too soon. However, Mr. Huefner notes, Germany is just respecting the fiscal rule it passed last year, which requires a balanced federal budget by 2016. “We think it’s a good thing, not least because it gives confidence to the market,” he says.

The strength of Germany’s economy “lies in its manufacturing sector,” says Klaus Abberger, senior economist at the Ifo Institute for Economic Research in Munich. “There are lots of engineers and clusters in manufacturing. Investors can benefit from high-quality manufacturing and international networks.”

Small and medium-sized enterprises (SMEs) make up the bulk of Germany’s economy, accounting for 99% of all companies and more than 70% of all employees. Such companies are often too small to benefit from economies of scale or to access global markets. Germany’s SMEs, however, are just the opposite, driving innovation and exports, with many of them the world leaders of their niche markets.

Hidden Champions

“We have 1,200 hidden champions,” says Marc Evers, director of policy for SMEs at the Association of Chambers of Industry and Commerce (DIHK) in Berlin. “They are not well-known, but they have the top positions in the world in their special, small markets.”

Since German SMEs can’t count on economies of scale, they have focused on extremely specialized products — especially in machinery and engineering — that are almost custom-made for the client. “So they get long-term contracts with their customers,” Dr. Evers says. “It’s almost like a monopoly because the customer doesn’t have other suppliers who can do the same thing.”

The country’s SMEs, however, are facing a period of change, as the heads of these companies reach retirement age. The DIHK estimates that in the next five years, 110,000 companies will be transferred to the next generation, and that number will rise in the five years after that. About 95% of German companies are family owned — a higher number than in other countries, notes Dr. Evers. First, these companies look within the family for a son or daughter willing and able to take over the business. Next, they look to their employees and to outside investors.

Besides the succession issue, SMEs, already accustomed to dealing with international partners, are looking to outside investors to tap capital to expand, he says. Venture capital in Germany remains relatively weak, and banks are the main source of financing for SMEs. “The financial crisis has shown how important it is not to rely only on banks,” Dr. Evers says. “It will become more important for SMEs to open to foreign investors.”

The world's leading investors, large and small, already benefit from the investment conditions in Germany. They praise the country's highly skilled workforce and a high quality of life, which were often viewed by businesses as too expensive. Labor reforms that began over a decade ago, along with changes to pensions and unemployment benefits mean that Germany no longer deserves its reputation as an expensive business location. Unit labor costs fell 0.2% between 2005 and 2009, compared with increases in most of Europe, according to Eurostat, the European Union’s statistical arm. According to “Competitive Alternatives: KPMG’s Guide to International Business Location 2010,” German manufacturing costs are just 0.9% higher than in the U.S., while Japan’s are 6% higher than the U.S.

According to Mr. Huefner of the OECD, “It is relatively cheaper to invest in Germany in terms of labor costs today versus in 2000.”

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