KfW Research: as a location for industry, Germany must dare to go new ways

• Private capital is very important: Venture capital is an employment booster for young innovative businesses and good for the start-up location
• Improving traditional location factors would strengthen Germany’s industrial enterprises. In addition, the use of tariffs should be a firm element of the economic-policy toolbox
• In the medium term, expanding the energy infrastructure, particularly renewables, can provide relief in the form of falling energy prices

Germany must dare to go new ways and invest in new things. In order to do this, it must attract private capital. “Germany must open up new economic sectors. This cannot be done unless private investors, too, invest more locally. For young innovative firms, venture capital is important to speed up their growth,” said Dr Dirk Schumacher, Chief Economist of KfW.

On Thursday Schumacher presented a comprehensive study by KfW Research on Germany as a location for industry along with a brief study specifically dedicated to domestic start-ups. One of the findings is that venture capital (VC) boosts employment in young innovative businesses. Whereas German start-ups that receive no venture capital grow by around 1.2 employees per year on average in the first nine years, start-ups that obtained VC at least once expand by an average 2.5 employees per year. By contrast, ‘normal’ SMEs in Germany that are not focused on strong growth expand by only 0.6 employees each year on average. In other words, VC-funded start-ups grow their workforce on average four times as fast as German SMEs overall and more than twice as fast as non-VC-funded start-ups.

So far, however, the German market often does not offer investors optimal conditions for exiting from businesses. That is why the exit pathways of many successful German start-ups lead to other countries. Since 2005, a total of 986 transactions have been recorded in which VC investors have exited again from their investments in Germany. Acquisitions by another company was by far the most important path to exit. These amounted to 899 transactions, with only 43 per cent of buyers domiciled in Germany.

“The regulatory and tax environment for start-ups in Germany should be improved in a way as to prevent innovative businesses from leaving the country. Germany needs greater support as a location for start-ups and innovation,” said Schumacher.

In their study on Germany as a location for industry, the authors of KfW Research made further recommendations on how to strengthen the country’s economy. All the data indicates that industrial value creation in Germany will continue on a downward trend for the time being. In this, the industrial sector is not just undergoing a normal process of adaptation, as it has already done several times in the past. More importantly, there are a number of geopolitical factors that are massively accelerating the downward momentum.

“More than in the past, the fate of German industry depends on factors that are beyond the direct control of businesses and the Federal Government. But the conclusion from that should not be resignation or inaction. Germany must undertake all efforts to apply the levers which we ourselves have in hand,” said Schumacher.

In addition to the need for strengthening Germany as a start-up location, KfW Research arrived at the following main findings:

• Germany must give its industry a reprieve: The headwinds which Germany’s industrial sector is facing are in part generated by government economic policy interventions in other countries, first and foremost, but not exclusively, in China. By taking a laissez-faire approach, Germany implicitly gives economic policy decisions made in other countries the power to shape German industry. “So long as China continues to pursue its mercantilist policy and the US an erratic America-first policy, tariffs should be part of the economic-policy toolbox,” said Dr Dirk Schumacher. Furthermore, Germany must reduce its heavy economic dependency on other countries. “Securing supply chains, for example for important natural resources, is a task for both the government and the private sector. Both actors have a part to play here,” said Schumacher.
• Traditional location factors should move back into focus: High labour costs, a somewhat inflexible labour market, excessive bureaucracy and, most of all, a very heavy corporate tax burden – by international comparison – are putting enormous pressure on Germany’s competitiveness. Economic policy needs to address this. “The scope of the reform effort needed here always depends on the pace dictated by other countries as well. And at least the pace of China and the US is very fast!”, said Schumacher.
• Energy costs must decrease: Germany is suffering from excessively high energy costs and an inadequate energy infrastructure. In the medium term, further expanding this energy infrastructure, particularly renewables, can provide relief in the form of falling energy prices. It may be necessary to subsidise energy prices for the time being. “That would improve our chances of keeping energy-intensive industrial businesses in Germany. If we expand renewables at the same time, hopefully the subsidies will then be only temporary,” said Schumacher.

The full study on Germany as a location for industry can be downloaded here Wettbewerb(sfähigkeit) neu denken: Deutschlands Industrie am Scheideweg | KfW (Re-thinking competition and competitiveness: Germany’s industry at a crossroads – in German)

The brief study “Start-ups in Deutschland – Wachstum und Exit-Wege über Venture Capital” (“Start-ups in Germany – growth and exit pathways through venture capital” – in German) can be found here Fokus Volkswirtschaft | KfW