Germany's interests - and those who can help realise them

Safeguarding our Prosperity via Free Trade and Innovation

Free trade and innovation are essential for Germany, given its lack of natural resources. Close strategic partnerships are needed to strengthen this core interest of German foreign policy.

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Free trade and innovation are essential for Germany, given its lack of natural resources. Close strategic partnerships are needed to strengthen this core interest of German foreign policy. Intensifying such partnerships beyond existing trade relations, whether with export markets in Latin America (for example Brazil) or Asia (for example Vietnam), and adopting innovation policy initiatives from similarly structured economies (for example Switzerland), should be the guideline for a forward-looking economic and innovation policy. In the aftermath of the Covid pandemic, it will be necessary to pursue new opportunities and potential because there is currently a real danger that our globalised world will drift apart, transport and supply chains will be put under pressure, and established connections between Europe and the rest of the world will be cut.

Generally speaking, only a few countries have been able to utilise globalisation in the way that Germany has – while, at the same time, economic growth was gradually decoupled from resource consumption. This is reflected in positive economic news from the labour market, solid growth figures, rising wages and pensions and stable tax revenues. There has also been success in ecological terms which will definitely need to be stabilised: the primary energy used to produce a unit of goods is declining, resource productivity is increasing, and greenhouse gas emissions are falling.

At the same time, the external risks for the German, export-oriented economic model have multiplied, including increasing protectionism worldwide (which started before the Covid pandemic), a US trade policy focused on China, overburdened ecosystems and unstable financial markets. It must be said that Germany also finds itself in a complicated geopolitical situation: in terms of trade policy, it is enormously dependent on China, it is closely linked to Russia in terms of energy policy, and, as far as security policy is concerned, its hands are almost tied without the USA.

Germany is thus stuck between these major powers wrestling with each other over who controls the narrative and it may have to state its own interests more clearly than in the past and must realise that economic success is not a foregone conclusion. Rather, it must be newly achieved again and again by pursuing a smart economic and innovation policy. Such a policy is characterised by a well-founded concept and is particularly focused on market economy aspects that can secure Germany’s future prosperity. This includes, on the one hand, a commitment to open markets, free global trade and an agenda that is geared towards globalisation. On the other hand, it is about establishing a culture of innovation that understands technological and social change as necessary conditions for increasing prosperity for everyone, as defined by Ludwig Erhard.

Germany’s economic performance depends to a considerable degree on exporting German goods and services, a significant proportion of which are exported to the EU, the United States and China. It is empirically well documented that the European single market and free trade with third countries can secure future prosperity through competition. Making the political case for this fact again and again remains a major challenge. It must be addressed in order to overcome resistance in society and allay fears about future trade agreements. The Covid pandemic and the tendency of individual countries to take unilateral action, which is linked to it, as well as increased protectionism, are making this task even more difficult.

Due to the German economy’s high degree of openness and integration into international value chains, a functioning, rule-bound, free trade regime is of paramount interest for Germany’s jobs, tax revenues and economic strength. In practical terms, this means that the German economy competes on a global scale and is therefore forced to stay innovative, kept on its toes by these productivity drivers. This requires German willingness to import goods from our trading partners and it requires refraining from protectionist measures such as customs duties or non-tariff trade barriers, which would make importing these goods even harder. The countries of origin would need to reciprocate, of course. However, fair cross-border competition between companies does require the observance of minimum ecological and social standards. The political agenda must therefore include the fight for fair competition rules (compliance with standards, no subsidies, respect for intellectual property, no barriers to market entry) and safeguards against protectionist tendencies.

As a member of the EU, Germany has transferred the competencies for international trade and investment policy, because the bargaining power of the union of states is far greater than that of individual member states.

With a gross domestic product (GDP) of 17.4 trillion US dollars, the EU is better able to negotiate with major economic powers such as the US (GDP: 18.6 trillion US dollars) and China (GDP: 11.2 trillion US dollars) and has achieved remarkable success in trade policy issues in recent years to the benefit of Germany. The EU’s first comprehensive free trade agreement was concluded with South Korea (in force since 2011). The agreement with Japan entered into force in February 2019 (JEFTA), and the European Parliament also approved the agreement with Singapore. Since 2014, the EU’s free trade negotiations with Ukraine, Canada (CETA), Vietnam and the South American Common Market (Mercosur) have officially ended. Ratifications are still pending, with the final approval of the agreement with Vietnam expected shortly. The Mercosur agreement, by contrast, is meeting with considerable social resistance due to the slash-and-burn farming in the Amazon and the political priorities of the Brazilian President, Bolsonaro.

Further free trade efforts (e.g. with Indonesia, Malaysia, India, USA) are proving to be difficult. This already became apparent during the negotiations with the United Kingdom, which became necessary after the country’s exit from the EU on 31 January, 2020. After a hard-fought battle, a trade and cooperation agreement was eventually signed in late 2020. From the German perspective, this agreement is important, because German industry is especially affected by the UK’s exit from the EU. Great Britain is the fifth largest partner in German foreign trade and is now one of the most important markets outside the EU. For this reason alone, it is important to keep the country as closely connected to the EU as possible and to view the negotiations as an opportunity. The political design of this agreement could set an example for future association agreements.

For a few years, the ambitious free trade agenda of Europe has contrasted sharply with the priorities of US administrations. This applied especially to the nationalist-protectionist policies of the Trump era, but even the current Democratic President Biden is not a champion of free trade, due to domestic policy constraints. China has experienced this kind of priority-setting in trade policy for some time now, which has led to an outright economic conflict between the two powers. Generally, the US is trying by various actions to decouple its economy from the Chinese economy in the long run.

Uncertainty about the future relationship between the two largest economies, the US and China, will not fail to leave its mark on the global economy, as global value chains are changing along with the conflict. The Covid pandemic will also act as an accelerator for Sino-American decoupling. Germany is directly affected. It must save transatlantic relations beyond the lost years of the Trump era and define a new economic policy approach to China – together with European partners –, because there is a kernel of truth to the criticism of US Presidents Trump and Biden regarding China’s global economic conduct. The regime in Beijing controls and intervenes in the economy, protects and develops powerful companies via industrial policy interventions and has benefited greatly as a freeloader in the global trade regime since it joined the World Trade Organisation (WTO). Chinese decisions in trade and foreign policy (such as the Made-in-China 2025 strategy, the Belt and Road Initiative (BRI), a new cybersecurity law, and a so-called social credit system) have made it clear to Europeans that China is willing to go its own way, and that it does not seek a seamless integration into the global economy.

Despite all this, the EU finally decided in 2020 to conclude a bilateral investment agreement (Comprehensive Agreement on Investment, CAI) with China, in order to establish a common level playing field for the global economy, to reduce access restrictions, and to create more fairness and reciprocity in the exchange of goods and services. Given the latest developments in China (Xinjiang, Hongkong) it is doubtful whether the European Council and the Parliament will ratify the agreement. The aspects of Chinese economic policy that have been criticized for years (market access, subsidies, forced technology transfer) will probably not change very much, which should lead to a reassessment of doing business with China.

It is not only the relationship with established trading partners and the initiation of new economic relations that is of immense importance for Germany as an export nation, but also a global trading regime that ensures the smooth cross-border exchange of goods and services. This is the task of the WTO which is mandated to promote multilateral cooperation by reducing tariffs and trade barriers. But more and more countries are concluding bilateral free trade agreements, thereby circumventing the WTO, partly because the organisation, being a membership-driven institution, often acts too sluggishly. The hope remains that, here as well, US President Biden will pick up the pieces left by his predecessor. Weakening the WTO was one of the issues Donald Trump vigorously pursued during his entire term. Now the institution that can protect rule-based global trade must be empowered again. The WTO will be needed in the future as a referee in an integrated global economy in order to make sure that the interests of emerging economies and developing countries will not be ignored. Germany is not interested in a global economic disorder and therefore needs to work intensively on reforming and strengthening the WTO, along with partners like Brazil and Switzerland.

Just as significant as trade policy is Germany’s ability to engage the future with creative answers. Innovation policy and the systematic expansion of national innovation systems are high on the agendas of the leading economic nations. Developing and emerging countries are also increasingly pursuing an innovation-oriented development strategy and rely on strengthening potential in the areas of science, innovation and human capital. The example of China, in particular, shows that a strategic medium and long-term plan towards an innovation and knowledge-based society can work. Developments in Saudi Arabia and Vietnam, for example, appear similarly dynamic.

The rise of new industrial competitors has given new impetus to the industrial policy debate in Germany, freeing up political forces and financial resources to further optimise the environment and infrastructure for research and innovation. It is essentially clear to everyone involved that, in the long term, Germany cannot limit itself to continuous improvement in the conventional sectors (motor vehicles, mechanical engineering, chemicals). Rather, the task is to inspire a new entrepreneurial spirit within society and to remain ready to change and open to technology. In ageing, saturated, rather risk-averse societies, this is probably one of the most difficult tasks for government action.

Nevertheless, the German 2025 high-tech strategy, with its numerous innovation policy initiatives, pursues these goals. It identifies six challenges that are of particular relevance for economic growth and societal prosperity in Germany, and which are to provide incentives for innovation policy: Economy and Labour 4.0; Security; Town and Country; Mobility; Sustainability, Energy and Climate; Health and Care. However, it is obvious that the state only has limited tools to promote promising technologies in these areas or to accelerate the transfer from research to application.

Thus, the long-term government commitment to pay the utmost attention to educational, innovation and research policy, and to provide the necessary funding is more important than discretionary programs and support initiatives like those mentioned above. Germany is currently spending around 3 percent of its GDP on research and development but is aiming for a medium-term target of 3.5 percent with an eye on its leading competitors, such as Switzerland and South Korea. Both the public and private sector must, of course, contribute to this higher investment.

This interaction will be crucial for promoting the structural change towards technology-intensive industries and could also become a competitive advantage, already established in the cooperative approach of the social market economy. In a market economy, it is private actors (medium-sized companies, family businesses and large companies) that generate exploitable innovations – given the right environment. These include corporate taxes which, in terms of their amount and structure, do not disadvantage German companies in the competition between industrial locations for less bureaucracy, a future-proof infrastructure, an effective education system, qualified specialists, competition and data law regulations that are suited to digitisation, and improvements to innovation financing.

Indicators show that there is a need for improvement in all of these areas. It is also true, however, that international indices acknowledge Germany’s efforts in innovation policy. In a comprehensive analysis, the Bloomberg Innovation Index comes to the conclusion that Germany is the most innovative country in the world. Various criteria are given for the ranking, from which an overall winner emerges. Germany scores particularly well on its patent applications, density of high-tech companies, and added value in domestic manufacturing . In the tertiary education sector, on the other hand, i.e. universities and other colleges, the Federal Republic has only a medium ranking internationally. Even if it is a good idea to take these international rankings with a grain of salt, they show that the ongoing debate about economic and innovation policy challenges can lead to remarkable political developments in the long term. This can be an incentive to access untapped potential.

The size of the German economy and the lack of any significant resources are enough to justify strategic thinking about innovations and engaging potential trading partners, such as Vietnam, Kenya, Saudi Arabia, Brazil or Switzerland, as a necessary condition for maintaining and expanding German prosperity. In the aftermath of the Covid pandemic, this task will become even more pressing. From exploring the topics in the previous section, two principles can be derived from the discussion of the issues in the previous paragraph for maintaining Germany’s economic momentum and for counteracting the virus-induced global economic slowdown.

First: A common level playing field must be respected in international trade, monitored by a reformed WTO based in Geneva, Switzerland, the importance of which should be recognised by the G20. This requires a critical dialogue with important trading partners so that globalisation can work to everyone’s benefit. The conclusion of new, or the modernisation of existing free trade and double taxation agreements can provide important incentives, in that they can incorporate high standards and fair market access regulations. Brazil, for example, could play a key role in terms of strengthening ties with South America in the context of an EU-Mercosur agreement, which, however, is not in sight for the time being. At the same time, the agreement is a litmus test for implementing the Paris climate resolutions as legally binding standards. The already ratified trade and investment protection agreement between the EU and Vietnam, from which Germany should especially benefit, pushes the door to Asia open a little further.

Second: Germany must be open to technological progress, taking into account not only the ethical and technological risks, but also and especially the opportunities for innovation. It is obvious that innovations should help people to live better lives. This requires a culture that promotes optimism about the future, courage, and a willingness to innovate (instead of a pessimistic attitude towards progress). A lot can be learned from other countries in this respect, especially when it comes to designing a favourable business environment. For example, due to its start-up culture and enthusiasm for digitisation, Kenya in East Africa is considered to be the model country on our neighbouring continent. In Saudi Arabia, too, a lot is being done to escape from the dependency on oil. With a reform-oriented, but controversial, crown prince, the country could become a laboratory of German engineering or a test site for German services. This will only happen, however, if there is visible progress in the area of human rights.

If the two principles emphasised here are reflected in practical policy, Germany can strengthen its competitiveness, participate as a major player in Europe and increase its prosperity.

David Gregosz was Policy Advisor for Economy and Trade in the Analysis and Consulting Division until August 2020 and heads now the KAS Office in Poland.

Last update: August 24th, 2021

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SWITZERLAND

as a partner for safeguarding our prosperity via free trade and innovation

In many ways, Switzerland is a central partner for Germany in terms of values and interests, particularly in the area of trade and innovation. The economies of both countries are closely intertwined: Germany has been Switzerland’s most important trading partner with more than 22 percent of foreign trade. Conversely, Switzerland is also a key economic partner for Germany: in 2018, it was number 9 among Germany’s foreign trade partners (and thus the fourth largest non-EU country after the USA, China, and the United Kingdom).

SAUDI ARABIA

as a partner for safeguarding our prosperity via free trade and innovation

The relevance of Saudi Arabia for Germany’s economic interests results from the country’s fundamental importance for stability and development in the Near and Middle East, the efforts to modernise its economy, and its oil wealth.

KENYA

as a partner for safeguarding our prosperity via free trade and innovation

Kenya is the most stable country in East Africa and is an economy that is oriented toward the west. With consistently strong economic growth in the twelve years before the coronavirus crisis and a GDP of just under 88 billion US dollars (2018), Kenya is the largest economy in East Africa and a growth engine for the entire region. Thanks to the port of Mombasa and the airport in Nairobi, the country is an important hub for trade and finance. Many international companies have chosen Kenya as the seat of their (East) Africa branches.

BRASILIEN

as a partner for safeguarding our prosperity via free trade and innovation

Brazil is the largest economy in Latin America and, with a GDP of approximately 2 trillion US dollars, is one of the most important emerging markets in the world. The country has a domestic market of 210 million inhabitants and is rich in natural resources.

VIETNAM

as a partner for safeguarding our prosperity via free trade and innovation

Vietnam is one of the few communist countries. A “socialist-oriented market economy” determines the country’s economic status, the communist party vigorously enforces its claim to total power, and the country is subject to fierce criticism in reports on human rights. At the same time, more than three decades of economic growth and political stability have led to Vietnam establishing itself as an influential player in Southeast Asia. An early and vigorous response to the coronavirus crisis has so far managed to limit the dangers to health and the economy.