Safeguarding our Prosperity via Free Trade and Innovation

A considerable part of German economic output depends on open markets, both in terms of importing raw materials, services and primary products and in terms of exporting German products and services. Germany’s key trading partners are the other EU member countries, the US 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 that must be addressed in order to overcome resistance in society and allay fears about future trade agreements.

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 agreements with Japan and Singapore entered into force in  2019 (JEFTA), the agreement with Vietnam in 2020. Free trade agreements have also been concluded with Ukraine and Canada (CETA). These, however, have only entered into force on a provisional basis. This also applies to the investment protection clauses in the agreements with Vietnam and Singapore, which have not yet been ratified by all EU member countries. The increasing difficulty the EU is facing in not just concluding free trade agreements, but also putting them into effect, is illustrated by the agreement with the Common Market of South America (Mercosur). Basically, negotiations on the agreement were finished in 2019. Due to the considerable social resistance to slash-and-burn farming in the Amazon and the political priorities of the Brazilian President Bolsonaro, however, political majorities required to put the agreement into effect have not been found. This situation seems to be changing, however, in the aftermath of the Russian invasion of Ukraine and the resulting shifts in geopolitical priorities. A window seems to be opening for new free trade agreements. This may have a positive impact on further EU free trade efforts (such as with Indonesia, Malaysia, India, the US), which have been very painstaking. 

At least, the EU finally managed to conclude a hard-fought trade and cooperation agreement with the United Kingdom 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 needs to revitalize 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 if it wants to integrate into the global economy at all, it will only do so on its own terms. 

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  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 EU 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. While US President Biden has at least picked up the free trade pieces left by his predecessor, he has not pushed for an active agenda for a much needed empowerment of WTO, either. However, 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, Mexico or Switzerland, especially at a time of US passivity.

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 are relying on strengthening their scientific, innovative and human capital potential. The example of China, in particular, shows that a strategic medium and long-term plan towards an innovation and knowledge-based society can work – at least under Chinese conditions. 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 traditional  sectors (automotive engineering, mechanical engineering, chemicals). Rather,  a new entrepreneurial spirit   needs to be awakened in a society that should be ready to change and be open to technological progress. Promoting this in ageing, saturated, rather risk-averse societies is probably one of the most difficult tasks for government.

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 prosperity in German society, providing incentives for innovation policy: Economy and Labour 4.0; Security; Urban and Rural Areas; Mobility; Sustainability, Energy and Climate; Health and Care. However, it is obvious that government 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 favoured by 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. This includes corporate taxes that, in terms of volume and design, do not disadvantage German companies in the competition between industrial locations,  less bureaucracy, a future-proof infrastructure, an effective education system, skilled labour, competition and data law regulations that are suited to digitalisation, 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 the 2021 Bloomberg Innovation Index, for example, Germany is ranked fourth, after having been honoured as the most innovative country in the world in the previous year.. Various criteria are considered 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 higher 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 moderate size of the German economy and the lack of any significant natural resources are sufficient reasons for engaging in strategic thinking about innovation as a necessary condition for protecting and expanding German prosperity. In the future, cooperating with various innovative partners such as Vietnam, Kenya, Saudi-Arabia, Brasil or Switzerland will be key for developing and using innovations.. In the aftermath of the Covid pandemic, this task will become even more pressing. Based on the discussion of the issues in the previous paragraph, two principles can be derived  for maintaining Germany’s economic momentum and for counteracting the crisis-driven global economic slowdown.

First: In international trade, a balance must be struck between supply security and  a  level playing field , 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 strengthening ties with South America in the context of EU-Mercosur negotiations that are picking up speed again. 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,  which would probably benefit Germany particularly, 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 at the helm, 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 play an active role  in Europe, thereby strengthening its supply security and competitiveness – and, in the final analysis, increase its prosperity.

Jan Cernicky was director of the KAS office in Kenya and the DR Congo until August 2020. Since then, he has been policy advisor for “International Economy and Trade“ in the Analysis and Consulting Division.
David Gregosz was policy advisor for International Economy and Trade in the Analysis and Consulting Division.

Last update: May 12, 2022