Creative Destruction in the Electric Vehicle Industry: East Germany’s Industrial Juggernaut Is on the Move

*** West Germany’s automobile industry is going through tough times. *** Berlin, Brandenburg, Sachsen-Anhalt, Thüringen and Saxony content with Southern Germany: Which German region will become the German car manufacturing hub of the future?


We bear witness to one of the most dramatic shifts in the European automobile industry, which will have repercussions for the whole automobile sector. The changes we are seeing will impact on the German energy industry. The energy sector and automobile industry go hand in hand, but this is something rarely discussed in Germany. It is not that there is a total lack of awareness, but there is certainly a lack of appreciation how big the challenge really is. Any discussion will have to center on how we can expand the production of electric vehicles; on how safety aspects compare. Different safety requirements exist, comparing electric vehicles to the hydrogen-powered cars. One thing is clear: The next big thing in Germany is how to integrate the energy sector and the automobile industry.


The German ‘energy revolution’ is a huge undertaking, and to match the scale and ambition of this project, huge investments will be made in the German energy grid.


What is the big trend in Germany right now? Stay with me for a few minutes, I will show you. If you drive with your car from Hamburg to Munich, or if you take a train from Cologne to Berlin, you will see the gargantuan scale of Germany’s pet project, and what Germany has done so far to become a leader in the renewable energy field, which comes at a huge cost to the population as a whole. German households (are they really prosumers?) have to pay one of the highest electricity prices (kWh) in all of Europe, which is putting a heavy burden on consumers, and to some degree, German taxpayers that must shoulder this cost, and subsidize the ‘energy revolution’.


The once mighty (agro)-chemical industry is curtailed by CO2 legislation. The steel industry is in decline, making an exodus from the Ruhr Region. One option is to leave the country once and for all due to high energy prices. Presumably, new industries will take their place. Surely, we did not think of heavy industry’s key requirement, which is to have a reliable, consistent power supply. In Germany, it is often widely believed natural gas is just a temporary measure. The overriding idea is that these new industries must be supported at all costs, renewable energy businesses first and foremost, with the aim to create national champions. The problem is that the renewable energy sector still relies on state subsidies and without these state subsidies it is unlikely that they could maintain production in their home market, which still is Germany.


Institutions were getting involved, and for a long time both private and public financiers were looking for new investment opportunities in the renewable energy field. Real estate prices kept creeping up in the years 2009 – 2019, the ROI of renewable energy projects were set against other investment opportunities, in real estate and other so called ‘solid investment opportunities’, basically brick and mortar.


What does Germany’s ‘Energiewende’ or Green Energy Revolution have to do with electric vehicles? Well, state subsidies have dried up for wind and solar energy, they usually receive subsidies for roughly 20 years. For green field developments, subsidies are now very restrictive. Even though real estate prices in big cities exploded, renewable energy projects in wind energy and biogas have performed badly. Without a hint of irony, investors began looking for alternatives. There are still generous subsidies for people wishing to drive electric vehicles and factories producing such fine cars. So now investments are flowing in that direction.


Electric vehicles are seen as integral part of the German energy revolution. But as it currently stands, most of the support comes from government, primarily based on state support for the electric vehicle industry in the form of government subsidies in one way or another.


The good news is that generous subsidies certainly help the country to develop East Germany’s car industry, but we shouldn’t become too focused on the idea that state-subsidies are the only factor why the state, banks and other financial institutions have focused on investment in the electric vehicle sector. To understand why, we need to look at Germany’s comparative advantage in industry, and the role that the automobile industry plays in the country.


The role of the automobile sector in the German economy


Germans heavily rely on the export of machinery and equipment, and German automobile manufacturers created machines that few foreign businesses can rival. Germany created machines everybody wanted. But Germany still sells diesel engines, these technical jewels are as magnificent as they are complex, and Germany sold them at a premium which left Germany`s automobile producers with a bigger profit. Diesel engines require a lot of technical components that are not to be found anywhere in electric vehicles. The dearth of mechanical components in EV’s somewhat explains why it is so easy for foreign market entrants to get a foothold in the global market for EV’s. German automobile industry is woefully unprepared for such economic displacement and creative destruction takes its toll on the German car manufacturers. Invention was replaced by innovation. These marvelous organizations expanded and blossomed, and have become stagnant.

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Let us take another look at how Germany’s technology sector performed in the last 20 to 30 years:


We see that German innovation centered on producing small widgets that fitted into other widgets that were fitted into machines. Small, niche products that were needed to bolster the emerging East Asian markets, and to bind European countries by the supply chain to the industrial juggernaut that was standing in the middle of Europe.


Germany’s comparative advantage lay in its unique ability to tie up design and horsepower into one compact machine. It was precisely this technological craftsmanship that nobody else was able to reproduce at a comparative price level. It obviously helped that competitors were never catching up in terms of innovation and quality control, and the innovation gap persisted for a while. It was hard for competitors to make cars just as reliable as German ones. This gap has now closed, but the cost base remains high due to high levels of unionization. This meant German companies were able to export to China, but at the same time consumption on goods and services sold in Germany has not increased very much at all. As we all know, consumption is a major component of GDP. In fact, consumption is the most significant part of GDP in Western countries.


German exports have increased dramatically, even compared to the period up to the recession in 2007. But when adjusted to inflation, salaries have not increased on par with productivity, and there is now a productivity gap. What does that mean for East Germany? It has meant even lower salaries in East Germany and in Eastern Europe, less unionization, it means access to the markets of Eastern Europe, and a large and growing consumer market in Eastern Europe where car manufacturers find a growing middle class. The new Silk Road crosses Eastern Europe, and snails right into East Germany. So now you have the choice: You no longer have to ship high-tech electric vehicles through the Netherlands, you can send components of electric vehicles to East Asia across Central Asia, along the vast rail network that is being created.


If we take a glance to what has happened in the 30 – 40 years before the collapse of the German Democratic Republic, we see that Saxony was a proud bastion of tech talent and technological achievement. Saxony was especially strong in the electronic manufacturing sector, exported chemical products, of even greater importance was the production of electronic equipment not just to the other Warsaw Pact member states, but also to Western countries, even more surprisingly to Western countries. During the communist period this tech legacy seemed to be part of a long held historic tradition, after all East Germany has not just been a region that has led Europe in electronics manufacturing, but has held a top seat in international education producing a long list of outstanding engineers and natural scientists, partly as a result of high quality education that was made available to large swathes of the population. This culminated in the build-up of the microelectronic industry and the eventual production of electromechanical devices for the production of electric vehicles.


The East German economy has been reawakened, in part thanks to international investors that dreamily envisaged how they could use these competences that lay dormant for years, and to use East Germany’s tech jewels to build a European tech hub. The production of microchips, EV equipment is in full sway. At best, East Germany was viewed as a distribution hub, at worst as a source of cheap labor, but with the added advantage of a highly skilled workforce. The entrance of foreign investors changed that, because for many investors East Germany is the springboard into the German and European markets for all the advantages that I have described above. That explains, in part, why there is renewed interest by domestic businesses to invest in East Germany, to compete for a highly skilled, relatively cheap workforce that is in short supply.


The East German solar industry almost collapsed in on itself, destroying hopes and dreams of a future with high-paying jobs and a secure existence. What is left are R&D centers for the development of solar panels, truly a stronghold of the East German economy. Two factors played a role: Subsidies and international competition. Subsidies for wind farms are drying up, eerily reminiscent of the solar industry collapse. Only trial and error will tell if East Germans have bet on the right horse.


Many thanks for the shared interest in the energy world!



Disclaimer:


This article is just meant to inform the reader of recent developments in the energy industry at large and to share knowledge and insights with a wider audience. The author does not put forth investment recommendations.

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