The capital offence of German companies

Germany needs an increase in investments, and much of it relies on private pockets.

Hardly a day passes without a German corporate boss urging the federal government to adopt their favourite policy. The wish list is familiar: lower taxes, flexible workforce changes, more public investment, less public spending, and tariffs to fend off Chinese rivals. However, looking at historically low valuations and earnings of German companies compared to US firms, does the fault lie solely on the government or should Germany’s bosses stop lobbying and start investing more instead?

When comparing Germany – and the EU, for that matter – to the US, one fact is that American companies are far more productive than their European counterparts. The disparity in productivity growth is so large: data show that output per German worker shrank by 0.1 per cent between 2018-2023 against a 1.2 per cent surge for US labourers, notwithstanding the effects of the COVID-19 pandemic. Germany is also an outlier among EU peers, as the economic bloc managed to raise labour productivity by 0.2 per cent over the same five-year period. We are not surprised, as we have long been cautioning about the reduced labour productivity of Germans due to fewer hours worked.

One could reason that much of this gap comes from the fact that the US is home to world-leading firms in information technology and digital investments while European countries are merely trying to catch up. This strategy requires huge investments – and, by European Central Bank’s former president Mario Draghi’s estimation, that would amount to EUR 800 billion (USD 910 billion) per year for the EU. While governments could get things started, bulk of these investments must come from the private sector.

Whose money?

Public investment initiatives like the EUR 500 billion (USD 570 billion) infrastructure fund in Germany naturally grab most of the attention when talking about the need for additional capital. However, public investment is typically dwarfed by private investment from companies, as seen in Graph 1. Across countries, up to 20 per cent of total investments comes directly from the state and the bigger chunk comes from private non-financial companies. Such is the case for Germany, where public investments are at 3.33 per cent of GDP and where capital from private corporations account for 17 per cent of GDP. Together, these account for a cumulative gross capital investment equivalent to 20.3 per cent of GDP.

While public investment in Germany did fall from 2.6 per cent to 2.2 per cent of GDP in the early 2000s before rebounding, private investment drove most of the ups and downs. The period from 2000 to 2009 saw a decline in investment worth four percentage points, which is larger in real terms given yearly (though soft) economic growth. Investments recovered somewhat in the late 2010s and has averaged at 21 per cent of GDP over the last five years. What makes this even more striking is the fact that non-financial corporations had both a high savings rate and a low investment rate – in effect, this made them net lenders during the last 20 years, something that is highly unusual for companies.

German firms did not stop building factories entirely; however, they stopped building them at home.

Lagging behind

Capital stock captures investments accumulated over the years. On that measure, German firms fell behind their European peers after the 2008 Global Financial Crisis as seen in Graph 2. Between 2000 and 2022, German capital stock grew by 93 per cent. In comparison, France’s capital stock grew by 126 per cent while that of Denmark and Norway surged by 132 per cent and 151 per cent, respectively.

It may be the case that German firms are not investing in the likes of machinery and equipment at the same level as companies in peer countries. That is true in services and in manufacturing, the latter being Germany’s pride. Intangibles are especially hit, and that includes software as well as research and development – two investments that raise productivity the most. Skimping on them is expensive. Not only does newer and more capital lead to more productive and competitive companies, shortfalls also reduce wage growth and weaken national demand.

The restraint was not irrational. In the short term, wage moderation and cheap Russian fuel supply allowed for cost cutting as carmakers were able to protect margins on combustion engines rather than being forced to write down the assets that produced them. However, there is only so much one can do in squeezing wages with gas prices staying high and Chinese rivals competing on technology as well as price. Lobbying is the cheap answer to problems, but this did not help for long.

As Germany’s export-led growth model slows and China takes significant market share in key industries like chemicals, power generation equipment, and cars, it is time for German firms to invest heavily. Berlin has a lot of work to do: public investment, easier rules for growing firms, and tax breaks for capital spending.  However, no tax break builds a factory by itself.

While there are legitimate economic reform policies that European and German politicians should enact, bosses will need to reassess their priorities. Do they want to build a firm that can win abroad, or will they keep haggling for exemptions while Chinese manufacturers dominate the industries Germany used to corner?

This original article has been produced in-house for Lundgreen’s Investor Insights by on-the-ground contributors of the region. The insight provided is informed with accurate data from reliable sources and has gone through various processes to ensure that the information upholds the integrity and values of the Lundgreen’s brand.