How Germany Became the China of Europe

Ten years ago, Germany's economy was a shambles. Now it's an export machine. What can America learn from an Old World tiger?

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Reinhard Hunger for TIME

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Europe's China
In many respects, Germany's role in the world economy is similar to China's. Both are manufacturing monsters that are bringing instability as well as benefits to the world. Because of its export machine, Germany, like China, runs up a humongous current-account surplus, while its less competitive neighbors, like Spain, have fallen into deep deficits.

These differences are at the heart of Europe's debt crisis. Many in the zone blame Germany's export-dependent economy for the region's economic woes, in the same way that Washington accuses China of hampering the U.S. recovery. Unless the economies of Europe are brought into better balance, some economists fear, the region could get stuck in a low-growth pattern that could make the debt crisis harder to resolve, threatening the future of the entire monetary union. Mimicking the argument Washington makes about China, Germany's European partners believe Berlin has to alter its model to better support regional growth. The European Commission, the E.U.'s governing body, has called on surplus nations like Germany to stimulate consumer spending at home in order to help support the E.U. economy as a whole. French Finance Minister Christine Lagarde has complained that Germany must show "a sense of common destiny" and reform its economy for the good of Europe.

Berlin, however, believes German exports are good not just for Germany but for all of Europe. Much like China in Asia, Germany sits at the center of a network of regional suppliers that feed its export industries with parts and other resources. The more German factories export, the more they suck in from Germany's neighbors, sparking growth well beyond its borders. Kampeter points out that German imports from the rest of the euro zone are expanding more quickly than Germany's exports to the region — 16.7% vs. 12.7% in 2010. "A growing Germany is better for the E.U. and the world economy than a Germany that is a shrinking economic power," he says. In German eyes, the answer to Europe's woes isn't a Germany that exports less but reform in the weaker economies to make them healthier and more competitive.

The German Model
It's a strong point. While the Spanish, Irish and other Europeans were gorging on debt, building too many houses and giving themselves fat pay raises, Germans were busy fixing their economy. German companies poured money into R&D and cut expenses. Loosening up the tightly regulated labor market to make it easier for firms to hire and fire helped. Union cooperation meant Germany was the only major European economy that reduced labor costs for several years after 2005. Germany churns out specialized products of such superior quality, from BMW sports cars to Kärcher cleaning equipment, that customers will pay extra for the "Made in Germany" label. That has kept the country in front of emerging economies like China's and helped it benefit from their rapid growth. German exports to China surged 45% in the first 10 months of 2010. In fact, Germany is the only major industrialized country other than Japan in which exports are playing a significantly larger role in the economy — 41% of GDP in 2009, from 33% in 2000. German industry may provide an answer to one of the thorniest economic issues facing the developed world: how to maintain manufacturing competitiveness against low-cost emerging economies. Germany "is a road map for the U.S. and other countries," says Bernd Venohr, a Munich-based business consultant.

German executives and policymakers also found inventive ways to ensure that factories kept their edge during the Great Recession. And the nation prevented the sort of large-scale layoffs the U.S. endured during the recession with a short-term work program in which the government subsidized firms to keep workers. At the program's peak, in 2009, more than 1.4 million workers were involved. At BASF's chemicals complex in Ludwigshafen, engineers worked furiously to keep the multibillion-dollar machinery running smoothly as production dwindled. At one of the facilities, demand for its ethylene and other chemicals sank from 100% of capacity to a mere 14% in just 100 days in late 2008. Unable to shut down superhot machinery in winter — the pipes could have frozen, causing costly damage — the plant's engineers kept the facility operating through a complicated recycling scheme. Instead of laying off cherished staff, management deployed idled workers to new assignments. Bernhard Nick, a BASF president, believes the measures taken during the downturn kept the company primed to capitalize on the recovery. "It wasn't just a family feeling or being nice to each other," he says. "Even the normal shift workers have such a high skill level, it is not so easy to lay them off. You lose a lot of knowledge, which would give you big problems starting up again."

Crisis Mismanagement
The successes are prodding the rest of Europe to become more German by copying Berlin's reforms. French President Nicolas Sarkozy stared down protesters late last year and raised the retirement age by two years — a step Germany took in 2007. In June, Spain's Prime Minister, José Luis Rodríguez Zapatero, pushed through the parliament a labor-reform bill, aiming, like Germany, to reduce the nation's perpetually high unemployment. But catching Germany won't be easy. Since Germany and its neighbors all use the euro, the zone's weaker economies can't employ the simplest tool to regain competitiveness — depreciating one's currency, which is the U.S.'s preferred way of reducing its trade deficit with China — and instead must suppress wages and costs.

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