Germany is the world’s industrial bazaar. No other country can offer its international clients such a broad variety of industrial products. Germany has 450 hidden world champions for niche products, and is home to 15 of the 20 biggest trade fairs in the world. It is also the world’s top exporter of merchandise and the second-largest exporter of goods and services.

But Germany is gradually becoming a bazaar economy in a different sense, because nowadays it specializes in packaging and selling its products, while outsourcing an ever-larger share of its high value-added manufacturing to low-wage countries. In other words, Germany’s role in the world economy is shifting from that of a producer to that of a merchant. As a result, its exports contain an ever-increasing share of imported goods and services and the share of domestic value-added in its exports per unit of output is rapidly declining.

This does not mean that the German-made share of exports is falling in absolute terms. It only means that the total volume of German exports has been rising faster than the total German value-added in those exports.

Is this good or bad? A favorable assessment cannot rest on the fact that the overall German value-added in exports has been growing because this is simply an effect of the German specialization in export-related production. When a country specializes in a certain area, capital and labor move into that area at a rate faster than they move into other areas – indeed, the growth of export-related sectors may come at the cost of a decline in other areas. Simply put, there is such a thing as excessive specialization.

To assess whether excessive specialization has occurred in Germany, we must focus on the labor market, for it is here that the effect of specialization is most visible. Unfortunately, there is no reason to be optimistic. From 1995 to 2004, Germany lost a total of 1.09 million full-time equivalent jobs in manufacturing and trade. At the same time, no new jobs were created in the rest of the economy. On the contrary, employment outside manufacturing and trade declined, so that the economy as a whole suffered a net loss of 1.26 million full-time equivalent jobs.

In fact, since the fall of communism, the percentage decline in German industrial employment has been larger than in any other OECD country. In part, this was due to the decline in the former East Germany. But even western Germany holds the second-lowest rank of all developed countries.

The automobile and electrical engineering industries have been at the forefront of the bazaar economy. To remain price competitive, they have had to rely on imported components. The manufacture of electrical products, such as chips and passive devices, has quite often been shifted completely to Asia, while even automobiles that are still assembled in Germany rely heavily on components produced in Eastern Europe.

At bottom, the coincidence of unemployment and booming exports can be explained by the high and rigid wages from which Germany still suffers. As a consequence of its welfare state and aggressive unions, Germany has had the highest hourly labor costs in the world for most of the last twenty years; only recently has Denmark taken the lead due to a revaluation of the krona. Excessive wages destroy the labor-intensive upstream product stages too fast and also impairs other labor-intensive sectors like textiles, simple services, tourism, and construction.

As a result, these labor-intensive sectors must release a lot of labor and capital, which push into the capital-intensive export sectors that are better able to cope with high wages. But, while these sectors therefore grow especially fast, their high capital intensity means that they cannot fully employ the released labor, with the result that some of the unemployed workers have nowhere to turn but the welfare state.

At the same time, since returns to capital are kept low by high wages, very little investment occurs. The excess of savings over investment flows abroad as capital exports. Economic growth and job creation slow, while exports soar.

Astonishingly, many interpret Germany’s export boom and current-account surplus, which measures these capital exports, as an indicator of the strength of Germany as an investment location. But, according to the Bundesbank, net investment abroad (including financial investment) has already roughly matched domestic investment in recent years.

As the international division of labor proceeds further, the import content of German products will continue to increase, which means that rising exports will lead to fewer domestic jobs and less income growth. Unless and until German workers accept the need for greater flexibility in the face of global competition, export profits will continue to be invested abroad, reducing overall production costs – and reinforcing the bazaar economy at home.

Read on www.project-syndicate.org