Table of Contents

Executive Summary................................................................................................................................. 2 Introduction: ........................................................................................................................................... 3 Long Term Trend in Economic Growth ................................................................................................... 4 Agriculture, Forestry, and Fishing ....................................................................................................... 4 Mining and Minerals ........................................................................................................................... 4 Industry and Manufacturing ............................................................................................................... 4 Energy ................................................................................................................................................. 4 Services ............................................................................................................................................... 5 Tourism ............................................................................................................................................... 5 Indicators of Economic Development ..................................................................................................... 5 Indicators ............................................................................................................................................ 5 Growth: ........................................................................................................................................... 5 Human Development Index: ........................................................................................................... 7 Other Measures .............................................................................................................................. 7 Factors Driving Economic Growth in Germany and Factors contributing to Poor growth ..................... 8 Germany: An Economic History ............................................................................................................ 10 Wirtschaftswunderzeit: 1945-57 ...................................................................................................... 10 Slowing Down: 1958-73 .................................................................................................................... 12 The three oil shocks: 1974-85 ........................................................................................................... 12 Single Unified Market: 1986-90 ........................................................................................................ 14 Country Risk Assessment ...................................................................................................................... 15 Risk Assessment ................................................................................................................................ 15 Germany A Competitive Analysis ................................................................................................... 16 Exhibits .................................................................................................................................................. 17 References ............................................................................................................................................ 35

DIWE Project Country Analysis - Germany

Executive Summary
This report is an attempt to analyse Germany in terms of its long term trends in economic growth, indicators of and factors driving the economic development, major economic policy changes and crises faced by the country and risk associated with trade perspective. Germany is one of the most developed countries in Europe. Though productivity is very high in agriculture, its agriculture sector is declining. Similar is the case with its forestry, fishing and mining industry. Germany is very robust in its manufacturing sector and excels in automobiles, machine tools and chemicals. It has been taking several initiatives in renewable form of energy in the energy sector. Services sector has been growing substantially with banking and finance being the most prominent ones followed by tourism. Human Development Index of Germany is 0.935 in year 2005 and it ranks 22nd in HDI value. It ranks 20th in terms of GDP in year 2005 (source: hrdstats.undp.org). There is also a growing concern over declining population of Germany. It has high literacy rate, life expectancy and standard of living. This proves that Germany is a high income developed country. Till recently German economy was characterised by high tax rates which hampered development to a large extent. Thus, Germany has implemented rounds of tax reductions to support economic growth, but still they are at high levels compared to other developed countries. Increased focus on R&D contributes majorly to economic growth. Though it is a robust economy it also has been seriously hit by the ongoing recession. Germany has a history of lot of turmoil and crises. It had to face defeats in both the world wars with it taking the most hit in both of them. It also saw the division and unification of Eastern and Western Germany. It also had to face the side effects of fall of fixed exchange rate system in 1972 as its exports became expensive. It was successful in taking measures to differentiate itself in terms of export and thus sustain the oil shocks to some extent. In spite of all the adversities Germany grew at a very high rate to be one of the most developed countries in the world. Germany ranks seventh in the world competitive index (source: World Economic Forum). It is the best country in terms of innovation and infrastructure. It also has significant advantage in terms of its markets which are one of the most competitive in the world. Germany has very high volumes of trade internationally, both in goods as well as capital markets.

DIWE Project Country Analysis - Germany

Introduction:

Germany is Europes largest economy and most populous nation. It is located in Central Europe and has common borders with Denmark, the Netherlands, Belgium, Luxembourg, France, Switzerland, Austria, the Czech Republic and Poland. Germany has a total area of 356910 square kilometres. It has a population of approximately 82 million (including 7.2 million foreigners). It accounts for the largest population among the member states of the European Union and is home to the third-largest number of international migrants worldwide. It is one of the most densely populated countries in Europe with 229 people per square kilometre. Only Belgium, the Netherlands, Great Britain and Northern Ireland have a higher population density in European Union. From historical perspective, Germany came into existence with the advent of the Cold War when two German states were formed in 1949, the western Federal Republic of Germany (FRG) and the eastern German Democratic Republic (GDR). But later on the decline of the USSR and the end of the Cold War allowed for German unification in 1990. Since then, Germany has expended considerable funds to bring Eastern productivity and wages up to Western standards. In January 1999, Germany and 10 other EU countries introduced a common European exchange currency, the euro. Germanys currency is Deutschemark. Germany has gender ratio of about 1.05 of male to female. The official language of country is German. Germany is a federal parliamentary republic of sixteen states. The capital and largest city is Berlin. Germany is a member of the United Nations, NATO, G8 and OECD. It is a major
3 DIWE Project Country Analysis - Germany

economic power with the world's third largest economy by nominal GDP and the fifth largest in purchasing power parity. The weather of Germany always remains pleasant; there is no much difference in average temperature here. The maximum and minimum temperature used to be 19 degree and 1 degree Celsius here. The humidity of Germany is between 60% and 90% and annual rainfall is between 600 to 800 mm. Germany remains a key member of the continent's economic, political, and defence organizations. Of the world's 500 largest stock market listed companies measured by revenue, the Fortune Global 500, 37 companies are headquartered in Germany. In 2007 the ten biggest companies were Daimler, Volkswagen, Allianz , Siemens, Deutsche Bank , E.ON, Deutsche Post, Deutsche Telekom, Metro, and BASF.

Long Term Trend in Economic Growth

A brief of factors, which are major contributors in Germanys GDP is given below,

Agriculture, Forestry, and Fishing

In 2007 agriculture, forestry, and fishing accounted for only 0.9 percent of Germanys gross domestic product (GDP) and employed only about 2 percent of the population, down from 4 percent in 1991. Despite Germanys high level of industrialization, roughly one-third of its territory is covered by forest. The forestry industry provides for only about two-thirds of domestic consumption of wood and wood products, so Germany is a net importer of these items After a quota imposed by the European Community Common Fisheries Policy, in 2005 the fishing industrys total catch was 330.4 million tons.

Mining and Minerals

Coal is Germanys most important energy resource, although government policy is to reduce subsidies for coal extraction. Coal production has declined since 1989 as a result of environmental policy and the closing of inefficient mines in the former East Germany. In 2005 Germany produced 24.9 million metric tons of hard coal and 177.9 million metric tons of brown coal. As of January 2006, proven oil reserves were 367 million barrels, a modest amount by international standards but still the fourth largest reserves in the EU.

Industry and Manufacturing

Industry and construction accounted for 29.6 percent of gross domestic product in 2007, a comparatively large share even without taking into account related services. This sector employed nearly 26 percent of the workforce.

Energy
In 2004 Germany was the worlds fifth largest consumer of energy; total consumption totaled 14.7 quadrillion British thermal units. The majority of its primary energy, including 90
4 DIWE Project Country Analysis - Germany

percent of its crude oil demand, was imported. Also in 2004, Germany was Europes largest consumer of electricity; electricity consumption that year totaled 524.6 billion kilowatt-hours.

Services
In 2007 services constituted 69.5 percent of gross domestic product (GDP), and the sector employed about 72 percent of the workforce. The subcomponents of services, as a percentage of total economic output, were financial, renting, and business activities (29.5 percent); trade, hotels and restaurants, and transport (18 percent); and other service activities (22 percent).

Tourism
Domestic and international tourism currently accounts for about 3.2 percent of gross domestic product and 2.8 million jobs. In 2006 Germany ranked seventh in the world in international arrivals, with 23.6 million international tourists.

Indicators of Economic Development

Countries vary greatly on the their level of contribution to the global economy, the extent to which it gets affected by the changes in the global landscape and the amount of growth it can have in the future-short term and long term. All these depend upon the countrys current level of economic development. A logical analysis would call for the question: How do we gauge the economic development of a country? Are there any parameters based on which we can classify a country as being developed, developing or under-developed. Hence, we proceed with the discussion, answering these very questions with the help of a set of economic and social indicators which come in handy while tracking the economic development of Germany.

Indicators
These measures of economic development can be put under four broad heads, each of them expanding its own list of indicators. (Refer to Exhibit 2.1 for pictorial representation) (i) Growth (ii) Development (iii) Human Development Index (iv) Other measures
Growth:

We understand Economic Growth as the increase in the amount of the goods and services produced by an economy over time. The major indicators which contribute to the list are explained briefly as follows, which are essentially the measures of economic performance in terms of the value of income, expenditure and output. (a) Gross Domestic Product (GDP): The total value of output produced within a country in a given time period. Its value stands at US $3,607,476.9 millions as on 2008.(Refer to Exhibit 2.2) (b) Gross National Product (GNP):
5 DIWE Project Country Analysis - Germany

This can be understood as the value of goods and services that the country's citizens produced regardless of their location. (c) Real GDP vs. Nominal GDP: This factor basically explains the existence of differences in price levels across various countries. (d) National Income: Though this factor gives us an indication of the development of an economy, there are a few limitations when it comes to using these factors to assess the level of development, due to the following reasons (i) Reliability of data (ii) Distribution of Income across all sections of the society (iii) Distorted picture due to influence of exchange rate (iv) Quality of life- not captured (v) Black Economy Its value stands at $38,860 (Source: http://ddpext.worldbank.org/ext/ddpreports/ViewSharedReport?&CF=1&REPORT_ID=9147&REQU EST_TYPE=VIEWADVANCED&HF=N&WSP=N) DEVELOPMENT: We need to emphasize on the fact that economic development is not the same as economic growth. Economic development incorporates the Human Welfare aspect into it. These are broadly the indicators which are of great significance. (a) Poverty Level: There are basically three current definitions of poverty in common usage: absolute poverty, relative poverty, and social exclusion. Absolute poverty is defined as the lack of sufficient resources with which to keep body and soul together. Relative poverty defines income or resources in relation to the average. It deals more with the absence of the material needs to participate fully in an average life. Social exclusion is a relatively new term which is being used to describe poverty worldwide. It has come to be defined as a shorthand label for what can happen when individuals or areas suffer from a combination of linked problems such as unemployment, poor skills, low incomes, poor housing, high crime environments, bad health and family breakdown" (Source: http://www.bbc.co.uk) The level of poverty in Germany, over the past many years has been captured in Exhibit 2.3. it can be seen that the level of poverty has been rising. (b) Economic Inequality: It comprises of the disparities in the distribution of economic assets and income. This term is also used when comparing two countries. It is a much debated topic whether it is a positive or negative phenomenon, both on utilitarian and moral grounds. Refer to Exhibit 2.3 for indication about its effect on Germany, it shows that there has been an increase in income inequality over time. (c) Progress: There are a lot of factors which contribute to the progress of a country on many fronts, the goal of which aims at making the man better-off. Progresses in Science and Technology, Business, Human Capital efficiency, other aspects are few to be considered.
6 DIWE Project Country Analysis - Germany

Human Development Index:

From experience, we see that there are certain limitations with individual indicators in terms of reliability and consistency. To counter these problems, we find that it is possible to combine few indicators to form an index of development. This combined index varies from organization to organization. The UN Development Report used the index of Human development index. The factors which form the essence of HDI are listed as below. (a) Life Expectancy ( also termed as Longevity ): It is the average number of years of life remaining at a given age. It is the average expected lifespan of an individual.( Steven M. Sheffrin (2003). Economics: Principles in action ) Its value is 77.3 years for male populations and 82.6 years for female population ( Refer to Exhibit.2.2) (b) Literacy rate ( Can be represented as Knowledge): It is the proportion of the population over age fifteen that can read and write. .( Steven M. Sheffrin (2003). Economics: Principles in action ). Its value stands at 99.9% as on 2008 ( refer to Exhibit.2.2) (c) Standard of living (captured by Purchasing Power Parity/ GDP per capita): The standard of living is generally captured by Purchasing power parity, which gives the information about the real income/person. Germany has a GDP (PPP) of $35,552. ( Source: World Economic Outlook Database-October 2008, International Monetary Fund.) Overall, Germanys HDI in 2005 was 0.935 and it stood 22nd in HDI ranking. In terms of GDP it ranked 20th in the world. This shows that it lags in development as compared to its growth. But still it fares very well as compared to other countries in terms of this difference. This is illustrated in Exhibit 2.3. Exhibit 2.4 suggests that HDI of Germany has been increasing over time (source: hrdstats.undp.org)
Other Measures

(a) Demographic indicators: We also need to take into consideration few demographic indicators such as Annual Population growth rate, Urban Population percentage(89%), Percentage of population under the age of 15 (13.7%) , Infant Mortality rate (3.7%) , which give us insights into the state of economic development of the country.(Values quoted from Exhibit 2.2) (b) Disease Indicators: The extent of diseases spread in many developing countries tells us about the low levels of health care, expensive drugs, contaminated water supplies, and poor health education. The factors which we might be interested in are percentage of adult population with HIV/AIDS, Malaria cases, Tuberculosis cases. Inter-Relationships between Indicators:

DIWE Project Country Analysis - Germany

One important issue which needs to be discussed when discussing the indicators of Economic Development is the interdependence between indicators. This concept is quite complex, in the sense that many a time, we cannot be sure of the interdependence. In spite of such a limitation, we present few relationships which are unmistakable, which we found out from secondary research. There is a strong positive correlation between GDP per capita and life expectancy of a country, however the relation is non-linear. This is can be explained with the logic of practicality. Suppose, there is a slight increase in the wealth of an individual, it raises his basic standard of living, which improves his life span. On the other hand, in developed countries, consider a huge expenditure on advanced medical care, thus increasing the life expectancy only marginally. We find that there is a positive correlation between the GDP per head and adult literacy. We also find that while the degree of correlation is high, it generally is a bit less (clear) when all the countries are taken into consideration.

Factors Driving Economic Growth in Germany and Factors contributing to Poor growth
There are several factors which impact Germanys economic growth. Some of the key factors are listed below. 1) Proposals from the government in March 2003 to reform labour markets and thereafter. There have been a number of proposals that are designed to reduce the sustainable level of unemployment using policies toward nonwage labour costs and wage moderation. The German labour market has increasingly suffered from skill mismatches and shortages, resulting in companies in a diverse group of sectors not being able to fill vacancies. After the 2002 general elections, the new government merged the labour and economics ministries into one super-ministry in a move to address more effectively the reform processes needed to revive growth and significantly reduce unemployment. Also, currently a foreign worker requires a salary of 85,500 to receive a work permit in Germany. The Federal Minister of Economics has proposed to cut this threshold in half which would allow Germany to draw skilled workers. 2) Tax policies impact growth significantly. High taxes on wages and corporate profits reduce the incentives of work and investments and, consequently, growth. Germany has implemented rounds of tax reduction to support economic growth. The German trade tax, which primarily accrues to the municipalities, has been degenerated to a tax on the profits of large companies. The large increase in value-added tax (VAT) rates from 16% to 19% in 2007 did not have a very significant impact though it hit the retail industry. Lowering Germany's average nominal tax rate on businesses from 38.7% to 29.8% from 1st January 2008 should improve Germany's investment climate. But the government aims to widen the tax base which is bad news for small and medium sized businesses. A 25% capital gains tax will also be introduced from January 2009.

DIWE Project Country Analysis - Germany

3) The structure of revenues and expenditures influences growth. In principle, expenditures on consumption and direct taxes represent particularly stubborn brakes on growth. High taxes on real capital, that is, primarily on company profits, and on the factor work, have a particularly negative effect. 4) Germanys structural change towards cutting-edge technologies is stumbling. This category of goods gains ever more importance in world trade, but Germanys respective foreign trade deficit rose from 1.5% in 1991 to 2.5% in 2001. And even in its traditional stronghold, the advanced technologies, the foreign trade surplus is dwindling. Germanys comparative advantage in foreign trade with R&D-intensive goods mainly rests on its automobile powerhouses. Dwindling of this segment is not a good sign for the country. 5) The total funds spent domestically on R&D in Germany rose slightly until the year 2002 (to 2.52% of GDP). This increase is credited to business only, as the states share on spending has been on the decline for years. But companies began to reduce their part in 20032004, too .The German governments 3% goal for 2010 (Lisbon agenda) seems hardly achievable. 6) Germanys market for venture capital has not yet recovered from the setback after early 2000 and does not display many signs of doing so soon. Thus, many companies, especially the young and innovative ones lack a main channel of financing. 7) Regulatory burdens on entrepreneurship and business in general are comparatively high in Germany. This includes, but is not limited to, labour market regulation and is empirically backed by the Global Competitiveness Report and OECD (Organisation for Economic Co-operation and development) studies. For example, the latter found that setting up a company in Germany takes exceptionally long (up to 24 weeks) compared to other countries like U.K, U.S.A, Japan and France. (Bar Graph attached-Exhibit 3.1) 8) The innovation contribution of German SMEs (Small and Medium Enterprises) is low and will probably decline further. The share of innovating SMEs fell steadily from 1998 to 2002, and SMEs spending on innovation decreased in 2001-2002 (particularly in manufacturing and distributive services; but a rise in corporate services). For the coming years, further reductions are expected. 9) Germany has recently become a location of off shoring. Companies such as AMD, General Electric, Honda, and GlaxoSmithKline have located central research and marketing functions in Germany. 10) The share of human resources employed in business R&D, relative to all employees, is high by international standards. This includes not only scientists and engineers, but also administrative and support staff. Germany ranks sixth internationally (2001), following Finland, Sweden, Denmark, Japan and Belgium. 11) The framework conditions for innovation are rated fifth-best in the world in the Global competitiveness Report 2003-2004 by the World Economic Forum. This indicator includes the strength of firm clusters and linkage of science and industry, among others.

DIWE Project Country Analysis - Germany

12) Germanys triadic patent output (per million inhabitants) ranks fifth worldwide, well above the OECD (Organisation for Economic Co-operation and development) mean and the US output and is still on the rise. In fact, the OECD and US values are stagnating and declining, respectively. This is a positive sign for Germany. 13) The supply of highly qualified personnel is bound to decrease, as expected graduate/retiree ratios among scientists and engineers as well as other highly qualified are expected to plummet in coming years. 14) German fiscal policy remains severely constrained by three important issues: The persistent dependence of Germany's eastern regions on major transfers of resources from federal and regional finance ministries in the west continues to absorb some 4% of German GDP. The European Commission continues to require that Germany remain the largest net contributor to the EU (European Union) budget. The deflationary imperative inherent in the euro-area's Stability and Growth Pact compounds the German government's fiscal plight. These imperatives are irreconcilable within the framework of the euro-area's current policy architecture. They would continue to collide with each other and compound Germany's growth weakness. The country has recently taken steps to combat recession. German officials have unveiled a 31 billion fiscal stimulus package in November 2008 to overcome recession. The government approved another 50 billion stimulus package in January 2009. The stimulus plan will not lead to an immediate restoration of economic health. Growth, with the help of the fiscal stimulus package, is expected to rebound towards the end of 2009, bringing it into positive territory in 2010. 15) German Monetary Policy- In the short to medium term, German macroeconomic indicators of output and employment are better under German targeting and active monetary policy. German output in the short term is much higher when German monetary policy is independent. However, the longer term benefits are the same irrespective of whether Germany has an independent monetary policy, and if it still had one it would not be able to reap the significant gains that should be available from a single currency rather than just a set of fixed exchange rates. If the Bundesbank were still running monetary policy in Europe the German economy would respond more quickly to the policy change, but in the long run the impact on output would be the same. However, inflation and hence interest rates tend to be higher in the short to medium term if Germany were in control of monetary policy.

Germany: An Economic History

Wirtschaftswunderzeit: 1945-57
On May 8, 1945 Germany was completely defeated and it unconditionally surrendered to the four allied powers. As a result of the Yalta conference, and subsequently the Potsdam conference, it was decided that Germany would be divided among the four Allied powers-the United States, the Soviet Union, the United Kingdom, and France, and would be administered jointly from Berlin.

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DIWE Project Country Analysis - Germany

Due to the difference in objectives, among the Allies and the changed leadership in the US and the UK, conflicts arose immediately among the allies over the implementation of the Potsdam agreements. The French occupation zone included the coal resources of the Saarland, and they wanted to eventually incorporate Saarland into the French mainland. The Soviets wanted to dismantle Germanys factories to eliminate the threat of renewed armament, and to help replace their own factories which had been damaged during the war. They proposed placing the Ruhr(which had the bulk of the factories) under international supervision so that a large part of its output could be directed to rebuilding efforts outside Germany. The British found the expenses of maintaining a large standing army and caring for a large refugee population army to be too high, and hence their policy became one of reconstructing German industry and rebuilding housing in their zone. The American policy, given by the Morgenthau Plan, was to dismember Germany politically, to dismantle its factories, and to maintain per capita income in Germany at the lowest level in Europe. However, they encountered the same problem of high expenses for maintenance of the refugee population to be too high, and hence the Plan could never really be carried out. By September 1946, American policy was converging with British policy and they decided to combine the operations of their zones from January 1947 as Bizonia. Subsequently, in May 1949, the Federal Republic of Germany was established, which also consisted of the French zone. Even though the Allied bombing had destroyed a large amount of capital stock in Germany, most of the machines in the factories were left undestroyed. Moreover, even during the retreat of the Germans during the war, the German factory managers were ordered to dismantle their machines, and not to destroy them, so that they could be used to help in the recovery from defeat. In fact, the German capital stock was much larger (in FRG alone) after the war as compared to before. Moreover, it was readily convertible to the production of civilian goods. Approximately 11 million individuals had poured into the western occupation zones of Germany in the ten years after the war. Even though many people had also left Germany, the overall population of the country had grown by more than 10% between May 1939 and October 1946. More people had also shifted from the big cities of Berlin and Hamburg to other rural areas as well. Moreover, the new population was predominantly filled with people who were well educated and at prime working ages. There were a large number of immigrants, who were highly motivated to work hard and save stringently in order to restore their material location quickly. Hence, the excess capacity of the German manufacturing plant could be staffed immediately by new workers eager for employment and easily trained. The US aid to UK and France also removed any claims that they had on West Germanys industrial plants for reparations. In June 1948, currency reforms took place and Deutsche mark was introduced. The occupation currency used until then, the Reichmarks quickly depreciated as there was no central control over the amount issued. The new currency was issued and was monitored by the central bank of Bizonia, Bank Deutscher Lander. Subsequently, France also joined in the same currency. The exchange ratio for Reischmarks to Deutsche marks was 1:10. This meant that the money supply drastically reduced by around 90%. Holders of money were wiped out, while people who owned physical assets were greatly benefited.
11 DIWE Project Country Analysis - Germany

Price controls were removed in most commodities and this lead to a surge in their prices. This encouraged dishoarding by merchants and also increased the revenue of the government. This allowed both the demand and supply to rise quickly without running into any constraints. Though the demand within Germany was primarily for scarce consumer goods, the West German economy had a well developed manufacturing sector that was well suited for producer goods, which were in high demand in other parts of war-torn Europe. Hence the West German economy was highly export oriented. All these factors lead to a good level of growth for Germany in the period following the Second World War.

Slowing Down: 1958-73

In 1961, the Berlin Wall was erected to compete the closure of the border of East and West Germany and to stop the flow of refugees, which it successfully did. This lead to a shortage in the availability of labour. In order to overcome this problem, the West German industry responded by initiating the Gasterbeiter (guest worker) program which was a huge success. The West German capital stock also continued to grow, mainly due to direct investment by British and American firms. Due to a high common external tariff within Europe, the companies wanted a base in Europe from where they could export to the rest of the countries in the area. The guest workers were mainly recruited from Spain, Yugoslavia and Turkey. Turkey especially had a large and growing population and was able to supply a large number of workers. Moreover, since the German workers were better skilled and educated, they got superior jobs as compared to the temporary workers, who got the low level jobs. This ensured that there was no resentment amongst the workers in Germany. West German firms continued to be highly competitive in the export markets, mainly thanks to their low costs of production due to cheap labour. The tight monetary policy of the Bundesbank, combined with fixed exchange rates of the deutsche mark with the other currencies of its trading partners, meant that the real exchange rate of the deutsche mark kept falling, making German goods more competitive. However, the rate of investment in West Germany slowed down, mainly due to a slowdown in the growth of the export markets. Investments that were made during the period were mainly to make use of the cheap availability of labour, and not to develop superior stocks of capital. There was also a demand supply gap for high skilled workers in certain sectors due to fixed quotas of workers in each domain under the apprenticeship program.

The three oil shocks: 1974-85

The Bundesbank had always been committed to ensuring price stability in the country. Till 1971, a system of fixed exchange rates was followed and the central bank was bound by the policy to ensure that the exchange rates did not change. However, once the fixed exchange rate regime collapsed in 1971, the nominal exchange rate of the deutsche mark rose sharply relative to most of its trading partners. This in turn meant that German exports became more expensive.

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DIWE Project Country Analysis - Germany

In order to remain competitive, the exporters had to either lower their prices or raise the quality of their product relative to other countries. One of the ways in which they improved quality was by setting up entire turnkey factories in developing count ries trying to build up a modern manufacturing sector from scratch. The factories would be fully setup and ready to use directly. In return, the buyer of the factory would enter into long term contracts for delivering intermediate products to the West German exporter for a number of years at fixed below market prices. A number of such contracts were made with Iran as well. Hence, when the first oil shock happened in October 1973, they were able to get oil at previously decided low prices. Moreover, the deutsche mark also continued to appreciate against other currencies. These two factors helped Germany weather the effects of the first oil shock better than other countries. However, the overall European economy had slowed down and this lead to a reduction in demand for German exports. Unemployment started to rise, and there were increasing demands from workers to send the guest workers back to their home countries. However, this was not very easy as many of them had already become eligible for emigration, which meant that should they be laid off, they would be entitled to unemployment benefits. In 1978/79, OPEC oil ministers doubled the price of oil again, and this lead to a further increase in unemployment. The dollar also began to strengthen against other currencies and this further made oil costlier for other countries. The German economy had been able to establish itself as one of the foremost economies of Europe, thanks to three key institutions that differentiated them from the rest of Europe 1. Co-Determination principle All companies had representatives from the labour unions and general public on their board of directors. The presence of workers on the board ensured that their wage demands were moderate and allowed the companies to grow by investing more money into the business. However, this caused a problem during the oil crisis as it became really difficult for companies to lay off or downsize to maintain competitiveness in the industry. 2. Elaborate Apprentice Program This was an elaborate training program conducted by the central, state and local government along with corporate businesses. This ensured that the level of human capital in the West German economy did not go down. This allowed businesses access to entry level workers who could be hired at cheaper rates while they were apprentices. If they were found suitable on completion of the apprenticeship, they could be hired full time. However, this system was highly inflexible, and lead to a shortage of jobs for apprentices in slow growing industries while there was a lack of workers in some other fast growing industries. 3. Relationship between banks and corporate Banks were allowed to own an equity stake in companies to which they lent money. Being privy to management decisions allowed banks to make better decisions regarding the profitability of any investment. However, in case of a bad business
13 DIWE Project Country Analysis - Germany

decision, the bank itself becomes hostage to its own actions as it was a part of the decision making process. To sum up, these institutions which had helped Germany to grow at phenomenal rates till the early 1970s failed to meet the challenges of the 80s and the 90s. The only way for Germany to continue to grow was to expand its exports and to further dominate in the European markets.

Single Unified Market: 1986-90

In 1986, a number of events occurred which helped reinvigorate the West German economy. The expansion of the European Economic Community to include Spain and Portugal lead to a large level of foreign investment from American, Japanese and European firms to try and capitalize on their low wage costs. All of these investments required construction equipment and machines, which were the strongest exports of Germany. The third oil shock lowered the price of imported oil. Moreover, the US government was also committed to a weakening of the dollar. The currencies of other European nations also strengthened and this created a uniform single market in Europe. However, despite this expansion, the unemployment rates in Germany did not decrease. Economists have attributed this to the hysteresis effect of unemployment, which basically says that once workers are used to generous unemployment benefits, refuse to take up new jobs unless it comes with higher wages. With time, they become less and less attractive to employers as their skills stagnate and eventually they become obsolete. The GATT negotiations were being held to try and discuss the lowering of non-tariff barriers in the EEC on trade with the rest of the world. Germany had become highly dependent on these barriers for its success. There were many sectors where non-tariff barriers did not let very cheap foreign commodities to be imported into the country. For example, coal which was produced at $100 a ton to maintain employment for coal miners and electric power plants and steel mills was subsidized for using it rather than being able to buy American coal for $10 a ton.

The Reunification Shock, 1990 onwards

On 3rd October 1990, East Germany united with West Germany. The first manifestation of the shock was the huge influx of young East Germans into West Berlin and into West Germany, who were keen to work and help in continuing the economic expansion that was taking place there. However, there was the threat of there being too many workers leading to the problem of unemployment, similar to the one caused by excess guest workers in the late 70s and early 80s. The key to solving the dilemma was to invest in East Germany itself. The German Economic and Monetary Union of July 1990 implemented this strategy. Upon adoption of the deutsche Mark in East Germany on 1 July 1990, the East German mark(ostmark) was converted at par for wages, prices and basic savings (up to a limit of 4000 Mark per person, except for children (less) and pensioners (more)). Larger amounts of savings, company debts and housing loans were converted at a 2:1 rate. This inflated exchange rate ensured that East Germans stayed put in their houses, and did not try to migrate

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DIWE Project Country Analysis - Germany

to West Germany. East Germany was a large new domestic market for West German firms who could now make higher profits through increased demand. The exceptionally high exchange rate also put the contractual wages of East German workers well above their productive levels thereby increasing unemployment. It also decreased the attractiveness of East German enterprises to foreign investors. It also made it difficult for East German firms to get financing because it took them at least 2 ostmarks worth of assets to get 1 deutsche mark worth of loan. This lead to a turnaround of the German trade account, which changed from one of healthy surplus in the late 1980s to one of deficit in the early 1990s. The fiscal prudence that had helped West Germany attain respectable levels of debt in the 1980s now seemed to be fading into the past as a result of the costs of reunification. The lack of private investment in East Germany, despite heavy government expenditure on public infrastructure in East Germany keeps unemployment high there. The continued extra reunification tax levied on West German individuals keeps unemployment high there as well. However, German efforts to improve the East German infrastructure seem be finally paying off with a resumption in growth in German exports. (Source: The Economics of Europe and European Union, By Larry Neal, First Edition, 2007)

Country Risk Assessment

Risk Assessment
Refer to Exhibit 5.1 for the year-wise details of the indicators discussed below. (Data Source: 2004, International Monetary Fund: International Financial Statistics Yearbook) Exchange Rate Prior to January 1999, the market rate was obtained from the Frankfurt foreign exchange market. In January 1999, the deutsche mark became a participatory currency in Eurosystem and euro market rates became applicable to all transactions. It can be seen that deutsche mark was appreciated from 2.021in 1992 to 1.97 in 1998, with respect to US Dollar. International Liquidity It can be seen that the reserve of US Dollar has decreased substantially from USD 85887 millions in 1992 to USD 41095 millions in 2003. This indicates the growing importance of euro, at least in the euro zone. Interest Rate It can be seen that Germany had very high interest rates (13%) in 1992, but they have been decreasing since then and came down to low levels (9%) by 2003.

15

DIWE Project Country Analysis - Germany

Balance of Payment From 1992, Current Account has been in deficit with fluctuating but reducing numbers. This continued till 2000 after which it turned to surplus and increased rapidly to USD 53.1 billion by 2003. Trade balance has been positive and increasing from USD 28.2 billion in 1992 to USD 149.37 billion in 2003. Capital account has not been significant but has been mostly in deficit. International Investment Position Germany has substantial investments done abroad. Direct Investments abroad have increased from USD 148.46 billion in 1992 to USD 645.95 billion in 2002. Also, institutional investments abroad have increased from USD 246.49 billion in 1992 to USD 1087.56 billion. There has also been substantial foreign investment. Foreign Direct Investments increased from USD 75.48 billion in 1992 to USD 510.32 billion in 2002. Foreign Institutional Investments have increased from USD 362.07 billion in 1992 to USD 1250.82 billion in 2002. Government Finance Total debt as percentage of GDP has been increasing in Germany. Domestic debt has increased from 25.41% of GDP in 1992 to 39.40% of GDP in 1999. Similarly, Domestic debt has increased from 25.41% of GDP in 1992 to 18.62% of GDP in 1999. Foreign debt i.e. external debt has also been increasing from 9.44% of GDP in 1992 to 20.42% of GDP in 1999.It is also to be noted that Germany has no debt outstanding from IMF since 1984 (www.imf.org). National Account Export of goods and services increased from 24.5% of GDP in 1992 to 35.7% of GDP in 2003. Imports of goods and services also increased from 24.7% of the GDP in 1992 to 31.5% of GDP in 2003. In 2008, exports were 42.8% of GDP while imports were 34.8% of GDP. This shows an increasing trend.

Germany A Competitive Analysis

Refer to Exhibit 5.2 and 5.3 for the details of the competitive indices. (Data Source: World Economic Forum) Germany ranks seventh in the global competitive index in 2007-08. This indicates that it is the seventh best country in the world to set up a business. Germany had a huge competitive advantage in terms of its infrastructure, in which it ranks first. Also, it fares the best in competitive markets and prevention of monopolies. It also fares the best in terms of innovation in 2007-08. But, it has got serious disadvantages in terms of Macroeconomic stability, education and labour flexibility.

16

DIWE Project Country Analysis - Germany

Overall, Germany fares well in terms of time required to setup business and procedures involved in the same. Thus, Germany seems to be a good place for investment.

Exhibits
Note that sources of the exhibits have been given in the text of the report

17

DIWE Project Country Analysis - Germany

Exhibits 1.1, 1.2, 1.3

18

DIWE Project Country Analysis - Germany

Exhibits 1.4, 1.5, 1.6

DEVELOPMENT

HUMAN DEVELOPMENT INDEX

Indicators of Economic Development

GROWTH

OTHER MEASURES

Exhibit 2.1 Measures contributing to the Indicators of Economic Development

19

DIWE Project Country Analysis - Germany

Exhibit 2.2 Statistical Summary of important parameters of Germany across the past five years

Exhibit 2.3

20

DIWE Project Country Analysis - Germany

Exhibit 2.3

Exhibit 2.4

21

DIWE Project Country Analysis - Germany

Year 2003 2004 2005 2006 2007 2008

GDP Real Growth (%) LEI - Male (year) LEI - Female ( years) Adult Literacy (%) -0.2 75.8 81.3 99.9 1.2 76.5 81.6 99.9 0.8 76.7 81.8 99.9 3 76.5 82 99.9 2.5 77.1 82.4 99.9 1.3 77.3 82.6 99.9

Exhibit 2.5

22

DIWE Project Country Analysis - Germany

Exhibit 2.6

Exhibit 2.7

23

DIWE Project Country Analysis - Germany

Exhibit 2.8

Exhibit 2.9

24

DIWE Project Country Analysis - Germany

Exhibit 3.1

25

DIWE Project Country Analysis - Germany

26
Unit Deutche Mark per US Dollar till 1998, there after Euros per US Dollar 2.021 1.93 1.92 1.87 1.9 1.96 1.97 Millions of US Dollars 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 41095 2.32 1.98 3.81 53.1 750.32 -600.95 149.37 0.36 85887 72727 72219 77794 75803 69853 64133 52661 49667 43710 42495 8.25 5.75 4.5 3 2.5 2.5 2.5 9.42 7.49 5.35 4.5 3.27 3.18 3.41 2.73 4.11 4.37 3.28 8.32 6.22 5.05 4.4 3.3 3.32 3.42 2.88 4.32 3.66 2.97 % per annum 8.01 6.27 4.47 3.85 2.83 2.69 2.88 2.43 3.4 3.56 2.65 13.59 12.85 11.48 10.94 10.02 9.13 9.02 8.81 9.63 10.01 9.7 7.96 6.28 6.67 6.5 5.63 5.08 4.39 4.26 5.24 4.7 4.61 -19.27 -13.81 -29.42 -26.96 -13.73 -8.66 -11.65 -2.69 -25.22 1.71 43.44 430.48 382.68 430.55 523.58 522.58 510.02 542.62 542.72 549.83 570.54 617.5 Bilions of US Dollar,-ve sign -402.28 -341.51 -379.52 -459.67 -453.2 -439.9 -465.71 -472.69 -492.38 -481.28 -489.3 means debit 28.2 41.17 51.03 63.91 69.38 70.12 76.91 70.03 57.45 89.25 128.21 -1.26 -1.15 -1.67 -2.73 -2.18 0.72 -0.16 6.19 -0.33 -0.23 148.46 156.7 188.32 234.13 250.14 296.28 365.22 411.94 484.86 545.17 654.95 246.49 279.91 320 385.42 413.69 502.7 724.01 893.3 1001.95 987.74 1087.56 Billions of US Dollars 75.48 71.17 85.72 101.48 101.73 188.88 250.34 288.56 460.64 404.5 510.23 362.07 486.93 493.72 636.9 705.11 756.01 1023.21 1083.63 1040.02 1060.26 1250.82 801.86 902.71 1004.15 1289.81 1373.07 1423.68 1461.87 772.44 Billions Deutche Mark till 1998, there after Millions of 504.03 496.94 610.53 762.27 791.26 758.67 716.52 368.41 297.83 405.77 393.62 527.54 581.81 665.01 745.35 404.03 Euros -2.6 -3.2 -2.4 -3.3 -3.4 -2.7 -2.2 -1.6 1.2 -2.7 25.41 27.90 29.58 36.61 38.29 38.83 38.78 39.04 % of GDP 15.97 15.36 17.99 21.64 22.07 20.69 19.01 18.62 9.44 12.54 11.60 14.97 16.22 18.14 19.77 20.42 774 736.5 800.1 862.3 908.8 1025.2 1092.1 586.4 686.1 731.5 757.6 Billions Deutche Mark till 779.8 729.5 787.1 837.4 869.5 974.4 1037.7 570.4 678.6 690.2 667 1998, there after Euros 3155.2 3235.4 3394.4 3523 3586 3666.6 3769.9 1978.6 2030 2073.7 2110.4 24.5% 22.8% 23.6% 24.5% 25.3% 28.0% 29.0% 29.6% 33.8% 35.3% 35.9% % of GDP 24.7% 22.5% 23.2% 23.8% 24.2% 26.6% 27.5% 28.8% 33.4% 33.3% 31.6% 761 670.5 2129.2 35.7% 31.5%

Heading

Sub-Heading

Exchange Rates

Market Rate

DIWE Project Country Analysis - Germany

International Liquiduty

Foreign Exchange

Exhibit 5.1

Discount Rate Money market rate Treasury Bill rate Interest Rate deposit rate lending rate Govt. Bond Yield Current Account Goods: Exports Balance of Goods: Imports Payment Trade Balance Capital Account Direct Investments Abroad International Institutional Investment Abroad Investment Foreign Direct Investment Position Foreign Institutional Investment Debt Debt: Domestic Debt: Foreign Government Fiscal Deficit(-) or Surplus Finance Debt Debt: Domestic Debt: Foreign Export of Goods and Services Import of Goods and Services(-) National Account GDP Export of Goods and Services Import of Goods and Services(-)

Index

Rank 7 7 14 14 6 6 13 21 4 11 27 77 4 22 62 19 31 4 13 15 15 9 14 13 5 1 3 4 4 4 3 5 8 2 40 58 60 32 10 105 24 14 16 1 23 8 16 23 10 12 28 36 17 52 11 21 35 25 43 29 23 44 21 30 8 5 12 A D D D D D D D D D D D A D A D D A D D D D A D A A A A A A A A D D A D D A A A D D A D D D A D D D D A

Global Competitiveness Index 2008-2009 Basic requirements SubIndex Institutions A. Public institutions 1.01 Property rights 1.02 Intellectual property protection 1.03 Diversion of public funds 1.04 Public trust of politicians 1.05 Judicial independence 1.06 Favoritism in decisions of government officials 1.07 Wastefulness of government spending 1.08 Burden of government regulation 1.09 Efficiency of legal framework 1.1 Transparency of government policymaking 1.11 Business costs of terrorism 1.12 Business costs of crime and violence 1.13 Organized crime 1.14 Reliability of police services B. Private institutions 1. Corporate ethics 1.15 Ethical behavior of firms 2. Accountability 1.16 Strength of auditing and reporting standards 1.17 Efficacy of corporate boards 1.18Protectionofminorityshareholdersinterests Infrastructure 2.01 Quality of overall infrastructure 2.02 Quality of roads 2.03 Quality of railroad infrastructure 2.04 Quality of port infrastructure 2.05 Quality of air transport infrastructure 2.06 Available seat kilometers* 2.07 Quality of electricity supply 2.08 Telephone lines* Macroeconomic stability 3.01 Government surplus/deficit* 3.02 National savings rate* 3.03 Inflation* 3.04 Interest rate spread* 3.05 Government debt* Health and primary education A. Health 4.01 Business impact of malaria 4.02 Malaria incidence* 4.03 Business impact of tuberculosis 4.04 Tuberculosis incidence* 4.05 Business impact of HIV/AIDS 4.06 HIV prevalence* 4.07 Infant mortality* 4.08 Life expectancy* B. Primary education 4.09 Quality of primary education 4.1 Primary enrollment* 4.11 Education expenditure* Efficiency enhancers SubIndex Higher education and training A. Quantity of education 5.01 Secondary enrollment* 5.02 Tertiary enrollment* B. Quality of education 5.03 Quality of the educational system 5.04 Quality of math and science education 5.05 Quality of management schools 5.06 Internet access in schools C. On-the-job training 5.07 Local availability of research and training services 5.08 Extent of staff training

Exhibit 5.2
27 DIWE Project Country Analysis - Germany

Goods market efficiency A. Competition 6.01 Intensity of local competition 6.02 Extent of market dominance 6.03 Effectiveness of anti-monopoly policy 6.04 Extent and effect of taxation 6.06 No. of procedures required to start a business* 6.07 Time required to start a business* 6.08 Agricultural policy costs 6.05 Total tax rate* 6.09 Prevalence of trade barriers 6.11 Prevalence of foreign ownership 6.12 Business impact of rules on FDI 6.13 Burden of customs procedures 10.04 Imports* 6.1 Trade-weighted tariff rate* B. Quality of demand conditions 6.14 Degree of customer orientation 6.15 Buyer sophistication Labor market efficiency A. Flexibility 7.01 Cooperation in labor-employer relations 7.05 Hiring and firing practices 7.02 Flexibility of wage determination 7.06 Firing costs* 7.04 Rigidity of employment* 7.03 Non-wage labor costs* B. Efficient use of talent 7.07 Pay and productivity 7.08 Reliance on professional management 7.09 Brain drain 7.1 Female participation in labor force* Financial market sophistication A. Efficiency 8.01 Financial market sophistication 8.02 Financing through local equity market 8.03 Ease of access to loans 8.04 Venture capital availability 8.05 Restriction on capital flows 8.06 Strength of investor protection* B. Trustworthiness and confidence 8.08 Regulation of securities exchanges 8.07 Soundness of banks 8.09 Legal rights index* Technological readiness 9.01 Availability of latest technologies 9.02 Firm-level technology absorption 9.03 Laws relating to ICT 9.04 FDI and technology transfer 9.05 Mobile telephone subscribers* 9.06 Internet users* 9.07 Personal computers* 9.08 Broadband Internet subscribers*

15 16 1 1 2 105 58 38 84 89 31 31 46 21 77 5 14 14 16 58 122 27 130 131 93 87 80 12 51 9 26 34 19 27 14 50 46 33 8 67 11 15 39 8 18 8 12 13 61 26 30 12 23 A D D D D D D D D D A D D D D A D D A D D D D D D D D D D A A A D D D D D D D D D D A

Exhibit 5.2 (conti.)

28 DIWE Project Country Analysis - Germany

Market size A. Domestic market size 10.01 Domestic market size* B. Foreign market size 10.02 Foreign market size* Innovation and sophistication factors SubIndex Business sophistication A. Networks and supporting industries 11.01 Local supplier quantity 11.02 Local supplier quality 11.03 State of cluster development B. Sophistication of firms' operations and strategy 11.04 Nature of competitive advantage 11.05 Value chain breadth 11.06 Control of international distribution 11.07 Production process sophistication 11.08 Extent of marketing 11.09 Willingness to delegate authority Innovation 12.01 Capacity for innovation 12.02 Quality of scientific research institutions 12.03 Company spending on R&D 12.04 University-industry research collaboration 12.05 Gov't procurement of advanced tech products 12.06 Availability of scientists and engineers 12.07 Utility patents*

4 5 5 3 3 4 1 2 2 2 10 1 1 4 2 3 4 10 8 1 6 5 6 34 26 A A A A D D A A A A A A A A A A A

Exhibit 5.2 (conti.)

Best Performing Countries/Economies Infrastructure Intensity of local competition Extent of market dominance Business sophistication Sophistication of firms' operations and strategy Nature of competitive advantage Capacity for innovation

Germany Germany Germany Germany Germany Germany Germany

Exhibit 5.3

29

DIWE Project Country Analysis - Germany

Exhibit 5.4

Exhibit 5.5

30

DIWE Project Country Analysis - Germany

Exhibit 5.6

Exhibit 5.7

31

DIWE Project Country Analysis - Germany

Exhibit 5.8

Exhibit 5.9

32

DIWE Project Country Analysis - Germany

Exhibit 5.10

Exhibit 5.11

33

DIWE Project Country Analysis - Germany

Exhibit 5.12

34

DIWE Project Country Analysis - Germany

References
1. http://hdrstats.undp.org/countries/country_fact_sheets/cty_fs_DEU.html 2. http://www.portal.euromonitor.com/ 3. http://www.weforum.org/ 4. The Economics of Europe and European Union, By Larry Neal, First Edition, 2007 5. http://ddpext.worldbank.org/ext/ddpreports/ViewSharedReport?&CF=1&REPORT_ID=9147 &REQUEST_TYPE=VIEWADVANCED&HF=N&WSP=N 6. http://www.bbc.co.uk 7. http://userpage.chemie.fu-berlin.de/adressen/brd.html 8. Http://www.economywatch.com/world_economy/germany/ 9. http://www.econstats.com/index.htm 10. http://www.industryweek.com/articles/german_industrial_slump_stuns_analysts_18 664.aspx 11. http://www.industryweek.com/articles/german_industrial_slump_stuns_analysts_18 664.aspx 12. http://www.spiegel.de/international/business/0,1518,590174,00.html 13. Current Issues-More Growth for Germany Deutsche Bank Research Report, June 22, 2004 14. Wage Moderation Policy In Germany -Ray Barrell, Bettina Becker and Sylvia Gottschalk, NIESR, 17th November 2003 15. Frankfurt Voice-More growth for Germany Deutsche Bank Research Report, December 23, 2002 16. Germany business environment: Europe's economic powerhouse re-emerges, Euro monitor International, 13 July 2007 17. In shoring to Germany Global networking is not a one-way street- Deutsche Bank Research Report, April 20, 2006 18. International Monetary Fund, International Financial Statistics, Yearbook 2004. 19. Steven M. Sheffrin (2003). Economics: Principles in action 20. World Economic Outlook Database-October 2008, International Monetary Fund. 21. www.imf.org

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DIWE Project Country Analysis - Germany