Hans-Werner Sinn

Nationalökonomie & Finanzwissenschaft

Ifo Viewpoint

Ifo Viewpoint No. 68: Investment is the Core Issue

München, 15. September 2005

Germany was the slowest growing country in the EU during the past ten years, from 1995 to 2005, and even western Germany by itself ranked lowest on the growth scale. At the same time, unemployment has reached a dimension which is hardly manageable, as shown by the continuing violation of the Maastricht criteria.

Most jobs are being lost in construction and manufacturing. The losses in manufacturing are especially bad, as industry is the backbone of the German economy, or the "red hot core" as Gabor Steingart so aptly called it. The core is cooling off a bit in many Western industrialised countries, but it is cooling faster in Germany than elsewhere. Nowhere else has manufacturing employment declined so much in percentage terms since the fall of communism as in Germany.

Germany's lowest rank position has little to do with unification, as western Germany by itself takes the second lowest position of all developed countries regarding the development in manufacturing employment. Despite the inclusion of about 2 million employees in east German manufacturing, total German manufacturing employment in 2004 was close to one million people below the level of west Germany alone before unification. Germany's manufacturing employment is dropping in free fall.

Job losses were especially marked in the early 1990s, then eased somewhat until 2000 and accelerated again thereafter. From 1995 to 2004, manufacturing employment in terms of fulltime equivalents (FTE) declined by 1.09 million without being replaced in the rest of the economy. Total German FTE employment fell by 1.26 million during that period.

Labour market and economic growth are stagnating because of a lack of investment. The German net investment ratio, i.e. the share of total net investment in net domestic product, amounts to only 3%. That is by far the lowest ratio of all OECD countries. Nowhere else have investors abandoned their country with similar resoluteness.

At the same time, households are saving because they fear for their jobs. Banks are swimming in money that nobody wants. The excess of saving over investment, measured by the country's current account surplus, is flowing abroad. At about 4% of gross domestic product, the current account surplus has reached a record level. Growth forces are moving elsewhere.

Most of the money is flowing abroad as financial capital. Where to is not well-defined, given the interconnections of the international financial system. However, the geographical distribution of direct investment has just been revealed by a new survey among 7500 firms by the German Chamber of Industry and Commerce (DIHT). Today's direct investment is centred primarily on the new EU member countries. At 43%, these countries lead the target countries of German firms' investing in 2005, even ahead of China, at 27%. China is then followed by the other EU countries, by the rest of eastern Europe and by North America.

The movement abroad is accelerating. 42% of companies active abroad are investing more abroad this year than last year, and only 12% are reducing their direct investment abroad. At 30 percentage points, the planning balance is the biggest since the surveys started in 1999.

The bigger the firms the easier comes the decision to invest abroad. Thus 69% of all firms with more than 1000 employees are planning new foreign investment in 2005. But the smaller firms are also going along. Among the class of firms with 200 to 1000 employees at least every other one is investing abroad this year.

Among the motives for foreign investment, marketing and service are on top, at 40% of the responses. But among the production decisions, the motive of cost savings (34%) ranks ahead of the motive of opening up new markets (26%).

Cost savings help the firms to remain internationally competitive. Thanks to the east European hinterland, to which more and more of the input chains are relocated in order to evade high German wages, German business can meet the challenge of Korea, China and other competitors. Contrary to popular beliefs, this does not usually create German jobs. Only 13% of the firms that create jobs abroad are planning to add to their German employment. The large majority, at 60%, is keeping domestic employment constant despite their expansion abroad, and 27% want to reduce domestic employment while creating new jobs abroad. Of the firms that invest abroad for reasons of cost only 10% want to create new jobs at home. 37% are planning layoffs in Germany. The popular thesis that foreign investment creates jobs at home is refuted by the DIHT, and it may be correct.

Whoever wins the election, this is the issue that must be dealt with. Ways must be found to make investors again interested in Germany and to restore the confidence that is necessary for them to keep their assets at home. If this path is not followed, nothing else will be achieved.

Hans-Werner Sinn
Professor of Economics and Public Finance
President of the Ifo Institute

Published as "Beschleunigte Flucht“, Wirtschaftswoche, No. 38, 15 September 2005, p. 154.