How the mittelstand drive Germany's economy

BERLIN, Germany — The backbone of Germany’s muscular economy isn’t in the big cities. It is in thousands of towns spread across the country, the homes of what Germany calls its mittelstand.

The mittelstand are the 3 million mid-sized businesses, often family-owned, that employ more than two-thirds of the country’s workers and contribute half of its GDP.

It is those businesses and their growing exports that German Chancellor Angela Merkel was aiming to protect at this week's G20 meetings in Seoul — an event that culminated Friday with world leaders agreeing to curb "imbalances" but putting off decisions on how to do so until next year.

Tital, a firm that makes precision titanium- and aluminium-cast products for the aerospace and race-car industries, is a classic example. Based in the small town of Bestwig in the Ruhr Valley, Tital has about 420 workers — mostly from the local area, trained through apprenticeships by the firm — and is owned by its management team.

The management doesn’t worry about quarterly growth figures but rather thinks long-term, said sales director Philipp Jerusalem. This approach allowed it to weather the financial crisis without needing to lay off any permanent staff.

“There is much more team spirit here,” Jerusalem said. “We would never jeopardize our long-term growth for short-term opportunities. Nobody is going to lose their job if we don’t grow for two years. It’s wiser to go slow and invest.

“That’s one of the secrets of the German mittelstand: most of them are managed by their owners; they grow long-term and they don’t have to please the financial community.”

Such firms are a major factor in Germany’s remarkable rebound. After suffering its worst recession since World War II, the economy will grow by 3.7 percent this year and 2.2 percent in 2011, according to the latest forecast.

Unemployment, now at 7.5 percent — compared to 9.6 percent in the United States — is expected to drop below 7 percent in 2011.

The mittelstand were also a key weapon in Germany’s tense war of words with the United States surrounding the G20 meeting in Seoul.

To the United States, Germany is relying too heavily on exporting its manufactured products — the sorts of things made by firms like Tital — and spending too little of its own money on other countries’ goods, harming their growth.

To Germany, the United States is trying wriggle out of its own torpor by pumping $600 billion into its economy with the QE2 stimulus, pushing down the dollar and helping its own exports while hurting countries like Germany.

Germany’s finance minister, Wolfgang Schauble, who plays bad cop to Chancellor Angela Merkel’s comparatively good cop, had the mittelstand in mind when he told Der Spiegel magazine this week that Germany’s exports were booming quite simply because its companies were more competitive.

“The American growth model, on the other hand, is in a deep crisis,” he said. “The United States lived on borrowed money for too long, inflating its financial sector unnecessarily and neglecting its small- and mid-sized industrial companies. There are many reasons for America's problems, but they don't include German export surpluses.”

Schauble may have been jockeying ahead of the G20 summit, but economists here say his argument is essentially sound: Over the past decade, German industry has become a lean, mean machine.

“We have a really healthy manufacturing sector. These goods have high demand, especially from the emerging markets,” said Volcker Treier, chief economist at Germany’s Association of Chambers of Industry and Commerce.

Tired of being called the “sick man of Europe” in the 1990s, German industry, with the help of the government, began to streamline around the turn of the millennium. Workers agreed to forgo big wage rises in return for job security and companies began investing at home rather than overseas, Treier said.

Now, emerging countries like China are laying their own foundations by buying things like precision machine tools for their factories — precisely the goods in which Germany specializes.

Treier was in China’s dynamic industrial city Shenzhen last week and visited a cargo plant.

“I saw a lot of freight coming and going,” he said. “Eighty percent was exports going out of China and 20 percent was imported machines from Germany. There were no flights either to or from the U.S.A.”

Treier describes the mittelstand as the “first column” of the German economy and says many are “hidden champions of the market.”

Because they are often based in small towns and regional centers, they tend to have more local, permanent workforces. This keeps wages down and means firms tend to avoid layoffs during tough times.

During the financial crisis, they were helped by Germany’s subsidized “Kurzarbeit” (short work) scheme, under which struggling companies could put their employees on shorter working hours rather than sacking them. The government then made up part of the workers’ lost wages.

This safety net worked brilliantly. Mass layoffs never happened and companies recovered more quickly once the climate improved because they still had a fully-trained workforce.

“I know a lot of companies that were helped by it,” Jerusalem said. “Imagine what a distaster it would have been if they’d laid off the people who they now need again today.”

Germany’s challenge for the future — and Merkel’s at the G20 in Seoul — is the issue of stimulating domestic demand so that the economy is not quite so lopsided in favor of exports.

The United States proposed a 4 percent limit on either trade surpluses or deficits, beyond which a country would have to find ways to boost its imports or exports to correct the imbalance.

No way, said Germany. Such a “political” approach was “neither economically justified nor politically appropriate,” Merkel said on Thursday morning. The resulting vague communique in Seoul reflected Germany's determination — and that of other big exporters such as China — to protect its export-dependent mittelstand.

In fact, Germany has already begun correcting its imbalance, economists here say. After years of wage restraint, workers are demanding a share of the spoils — and bigger pay packets will mean more consumption. In this cause, workers are even backed by pro-business conservative politicians.

“It’s interesting that even the conservative politicians in Germany are saying that wages should increase,” said Michael Holstein, head of macroeconomic research at DZ Bank. “We think wages will grow more strongly and the economy will go more in the direction of stronger domestic demand.”

By lessening its reliance on exports, Germany will have a broader, more resilient economy, he said. Like most economists, Holstein believes that, while there are plenty of challenges on the horizon such as the ageing of the population, the need for skilled migrants and necessary improvements to the education system, Germany is looking pretty good.

“There are still problems to be solved,” he said. “But over the next few years, we are quite optimistic about the German economy.”