304. What Are the Secrets of the German Economy — and Should We Steal Them?

Smart government policies, good industrial relations, and high-end products have helped German manufacturing beat back the threats of globalization.

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:01Stephen J. Dubner?

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• 0:48Stephen J. Dubner?

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• 1:19Stephen J. Dubner?

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• 2:09Stephen J. Dubner?

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• 2:46Stephen J. Dubner?

  Unless you have managed to totally tune out every American politician, you've probably heard that our manufacturing sector has been crushed.

• 2:57Speaker 01

  We have had, for the last 30-plus years, disastrous trade policies.

• 3:03Speaker 02

  We've lost 60,000 factories since China joined the World Trade Organization in 2001.

• 3:11Stephen J. Dubner?

  The consensus estimate is that we've lost about 5 million manufacturing jobs since 2000. There are a number of factors, but clearly, one of them has been global trade. We estimate that as much as 40% of the drop in US manufacturing between 2000 and 2007 is attributable to the trade shock following China's accession to the WTO in 2001. That's David Autor, a labor economist at MIT. You may remember him from an earlier episode of ours called "Did China Eat America's Jobs?" Short answer: yes, at least a good portion of them. Autor points out that there were gains in non-manufacturing sectors, which more than offset the number of lost manufacturing jobs.

• 3:53Stephen J. Dubner?

  But these new jobs typically pay less and leave workers worse off. Or, as an economist would put it... The reallocation process seems to be slow, frictional, and scarring.

• 4:08Stephen J. Dubner?

  The US is hardly alone in losing those good, old, high-paying manufacturing jobs. Many big, old, successful Western economies have suffered the same fate. This downturn has changed our politics in the US.

• 4:23Speaker 02

  We can't continue to allow China to rape our country, and that's what they're doing.

• 4:29Stephen J. Dubner?

  And elsewhere.

• 4:30Speaker 03

  I think you see it obviously in the UK vote to leave the EU. You're seeing it in other parts of Europe, a spread of this desire to kick back against globalization. You're seeing it here in this country.

• 4:41Stephen J. Dubner?

  But there's one big, rich, Western country that's different.

• 4:45Speaker 04

  We don't hear that sort of anti-globalization, anti-China rhetoric.

• 4:51Stephen J. Dubner?

  It's a country whose manufacturing sector has proved remarkably resilient.

• 4:55Speaker 04

  So the United States, the manufacturing share today is below 9%. I mean, we still have, you know, 22% or 23% of the workers active in manufacturing.

• 5:06Stephen J. Dubner?

  It's a country that not only doesn't have a trade deficit, but has one of the largest trade surpluses in the world.

• 5:12Speaker 05

  The exporting sector is doing very well, so it's a good sign.

• 5:17Stephen J. Dubner?

  So what is this ubermensch of a country?

• 5:22Speaker 04

  So at the moment, there's a bit of euphoria in Germany, right? So kind of, yeah, the economy's doing great, unemployment has almost disappeared.

• 5:31Stephen J. Dubner?

  That's right, it's Germany.

• 5:33Speaker 04

  So at the moment, the mood is really good here, but I think, I mean, yeah, Germans are also melancholic people.

• 5:41Stephen J. Dubner?

  Today on Freakonomics Radio, how did the German economy go from rubble to rock star? Germany has a very unusual economic geography.

• 5:53Speaker 05

  Germany is not a shareholder economy, it's a stakeholder economy.

• 5:57Speaker 06

  In Germany, the unions have representatives on the board of the company.

• 6:03Stephen J. Dubner?

  And what would happen if the US tried to copy the German model? We'll get into all that right after this.

• 6:21Speaker 07

  From WNYC Studios, this is Freakonomics Radio, the podcast that explores the hidden side of everything. Here's your host, Stephen Dubner.

• 6:36Stephen J. Dubner?

  I'd like you to meet Jen Sudakum.

• 6:37Speaker 04

  Yeah, hello. So I'm professor of economics at Dusseldorf University.

• 6:42Stephen J. Dubner?

  His research specialty?

• 6:43Speaker 04

  And yeah, I do research in international trade.

• 6:46Stephen J. Dubner?

  A few years back, Sudakum and his colleagues read the research that David Autor and his colleagues published about the American manufacturing crash.

• 6:56Speaker 04

  And I mean, the tone was very negative, right? The United States, that China cost millions of jobs, put so many people out of work, led to reduced wages. So basically, we just wanted to understand if that's also going on in Germany.

• 7:12Stephen J. Dubner?

  Sudakum applied the same research methodology to Germany. He found that, as in the US, some German industries did suffer a lot because of low-cost Chinese manufacturing, but...

• 7:24Speaker 04

  But then, on the other hand, I mean, overall, the overall conclusion that comes from our study is much more positive. I think the important difference is Germany just managed to take advantage of this gigantic export market.

• 7:38Stephen J. Dubner?

  The gigantic export market being primarily China.

• 7:42Speaker 04

  And so overall, if you add both together, that trade basically had zero impact on the manufacturing share itself in Germany.

• 7:53Stephen J. Dubner?

  Why was Germany able to find an economic equilibrium that has escaped so many other countries? To find that answer and to appreciate the magnitude of this economic turnaround, we have to go back in time a bit. Let's start just after World War II.

• 8:08Speaker 06

  And you know, Germany was basically rubble and demoralized, obviously for very good reasons, in deep shame.

• 8:18Stephen J. Dubner?

  Uwe Reinhardt is an economist at Princeton. He was born in 1937 in the countryside near Cologne.

• 8:25Speaker 06

  And so by and large, we young people had this burden of shame put on our shoulder. We never asked for that, but we had it. And so I sometimes think one outlet is just to work like hell. And to say, let's just work and see if at some point we will once again be, the German word is "der longfeig," meaning be fit to invited to a civilized party. So we worked hard, everyone worked hard. I remember I worked in Cologne as an apprentice, you know, everything was rubble. And then, you know, you saw year by year, oh, here was rubble, there's a new building now. You literally saw Germany sort of grow again.

• 9:11Stephen J. Dubner?

  Germany's growth was helped along by American financial aid. Here is US Secretary of State George Marshall, nearly two years after the end of the war, speaking at Harvard, where he was receiving an honorary degree.

• 9:24Speaker 08

  Ladies and gentlemen, I'm profoundly grateful.

• 9:27Stephen J. Dubner?

  Marshall used this occasion to announce a plan to rebuild Europe.

• 9:31Speaker 08

  The truth of the matter is, that Europe's requirements for the next three or four years of foreign food and other essential products, principally from America, are so much greater than our person's ability to pay, that she must have substantial additional help or face economic, social, and political deterioration of a very grave character.

• 9:51Stephen J. Dubner?

  The Marshall Plan sent a lot of money to Europe, the equivalent of more than $100 billion today.

• 9:56Speaker 09

  And initially, there was a bit of a controversy, I think, whether Germany in particular should be a recipient of Marshall aid.

• 10:04Stephen J. Dubner?

  That's Jeremyn Zettelmeyer. Until recently, he was a senior official in Germany's Ministry for Economic Affairs. Now he is a senior fellow at the Peterson Institute for International Economics.

• 10:15Speaker 09

  But, you know, as the politics changed after the war and the Cold War became the most pressing issue, so containment of the Soviet Union, it was very quickly decided that Germany would get Marshall Plan aid. And so it played a big role in German post-war reconstruction.

• 10:31Stephen J. Dubner?

  Reconstruction, that is, in West Germany.

• 10:33Speaker 10

  So it's well known that, you know, in the wake of the Second World War, Germany was occupied.

• 10:39Stephen J. Dubner?

  And that is The Economist, Daniel.

• 10:42Speaker 10

  In Anglo-Saxon countries, I'd say "sturm," but a German would say "sturm." So it's a difficult one.

• 10:50Stephen J. Dubner?

  Sturm grew up in Germany and now teaches at the London School of Economics. His specialty is called spatial economics.

• 10:57Speaker 10

  Well, spatial economics is sort of a umbrella term for people who are interested in the role of space in economic activity. So that could be space across countries. As sort of studied in international trade, that could be space across regions, or the role of space within cities.

• 11:15Stephen J. Dubner?

  You can see where this is going, can't you? After the war, Germany was divided and occupied by the Allied Powers. For a spatial economist who happens to be from Germany, this division would provide a perfect natural experiment. There was West Germany.

• 11:32Speaker 10

  Which was the combination of the American, British, and French zone.

• 11:35Stephen J. Dubner?

  And East Germany.

• 11:36Speaker 10

  Which was the Soviet zone.

• 11:38Stephen J. Dubner?

  The border between West and East Germany was also a border between capitalism and communism. In the West, cities like Hamburg, Bonn, Frankfurt, and Munich began to rebuild and resume their capitalist pursuits. Not so in the East, and Berlin lay firmly in the East. Before the war, it was the capital of Germany, easily its largest city, and an economic powerhouse. Now, it too was divided, eventually by the Berlin Wall. West Berlin was officially part of West Germany, but it was an island of capitalism in a sea of communism.

• 12:15Speaker 10

  So a lot of industries are forced to relocate and find new homes in West Germany.

• 12:20Stephen J. Dubner?

  And so it was for four decades, until November 9th, 1989, the fall of the Berlin Wall.

• 12:41Speaker 10

  When the Berlin Wall came down, I was just serving in the army. There was still conscription at the time. I was a lorry driver, so I was sort of servicing the spatial economy at that point, transporting goods around for the German army. But I had no training economics at that point.

• 13:01Stephen J. Dubner?

  But years later, Sturm, the economist, began to examine the economic data generated by the political divisions.

• 13:09Speaker 10

  So one of the classic questions in spatial economics is the question, why do people, firms and workers locate where they locate? And there's sort of two big competing theories. One is there is something fundamentally good about some locations, maybe access to a river, nice weather, or other location advantages. And the competing theory is that it's really cumulative causation. Once a critical mass of economic activity has been established in a location, people will just gravitate to that location. So there's nothing inherently good about the location, other than that many other people have decided to locate in that location as well.

• 13:51Speaker 10

  So trying to distinguish between these two explanations unfortunately is very difficult.

• 13:57Stephen J. Dubner?

  Difficult, especially when you can't run experiments in economics the way you can in other fields, when you can't, say, divide a country in half and cordon off its most important city to see what happens there. But of course, that is essentially what happened in Germany. Before the war, many large industries were concentrated in Berlin, but they shriveled during the Cold War. Now, after reunification, Daniel Sturm and a colleague, Steve Redding, took advantage of this shock to the system.

• 14:32Speaker 10

  So once that shock dissipates, do we see that everything gravitates back to its old pre-war equilibrium, which would suggest that everything is driven by fundamentals? Or do we see that the new location pattern that was developed during division continues after reunification, so we don't go back to the old pattern, but stay in the new pattern that has been developed during the shock period of division?

• 14:57Stephen J. Dubner?

  Now, granted, a city like Berlin can't just flip a switch after 40 years and tell all its big companies to come home. They had built buildings. Their workers had homes there. Still, Sturm felt he could at least address the question by looking at the data. First stop, airplane traffic data.

• 15:17Speaker 10

  The main reason we looked at air hubs is it's a sector where you get a lot of historical data.

• 15:23Stephen J. Dubner?

  Before the war, Berlin had the biggest airport in Germany.

• 15:26Speaker 10

  It was in fact also the biggest airport in Europe.

• 15:29Stephen J. Dubner?

  But during the post-war occupation, a lot of airplane traffic migrated to Frankfurt, in part because the US military had its main airbase there.

• 15:37Speaker 10

  And it took till the mid-1970s for Frankfurt to sort of fully take over the role as hub airport for Germany and for Berlin to fully fall back into sort of the role of a regional provincial airport.

• 15:52Stephen J. Dubner?

  Okay, not that surprising that Berlin's airport fell out of favor during the occupation, but what happened after reunification? Did Berlin recapture all that air traffic, or did Frankfurt retain its hold?

• 16:05Speaker 10

  And that's exactly what we find.

• 16:06Stephen J. Dubner?

  That is, Frankfurt retained its hold.

• 16:09Speaker 10

  There's no evidence of the pattern of air travel gravitating back to its old pattern.

• 16:16Stephen J. Dubner?

  To this day, Frankfurt has the biggest airport in Germany, with more than 60 million passengers a year. Berlin, while still easily the biggest city in Germany, has only the fourth and seventh busiest airports, which combined have only about half the traffic of Frankfurt.

• 16:31Speaker 10

  Germany is the only European country where the country's main air hub is not in the largest city. So you can sort of see the unusualness of the German situation. So if division hadn't happened, it would be very difficult to believe that Germany's main air hub today wouldn't be in Berlin.

• 16:50Stephen J. Dubner?

  The air traffic story is compelling because the data are so definitive. In other cases, it's hard for an economist like Sturm to make such a clean comparison between cities. But, he argues, the anecdotal evidence at least suggests that the air traffic data are part of a larger economic pattern.

• 17:09Speaker 10

  If you look, for example, at Munich, both Allianz, Germany's biggest insurance company, and Siemens, its biggest manufacturing conglomerate, moved to Munich in response to division. Similarly, the banking sector, you know, left Berlin and migrated to Frankfurt, which prior to the war was sort of a secondary banking centre. Similarly, publishing went to Hamburg, and we can continue in this way.

• 17:37Stephen J. Dubner?

  In other words, one indirect consequence of the war and the resultant political division was that the German economy became more decentralised.

• 17:46Speaker 10

  Germany has a very unusual economic geography, or a very unusual distribution of economic activity and space. It's a much more decentralised country than some other European countries such as the UK or France or even Spain, where economic activity seems to be highly agglomerated in one or two leading centres. In contrast, in Germany, you have a number of sort of mid-sized towns that have very vibrant economic structures, such as Munich, Frankfurt, Hamburg, and many more.

• 18:22Stephen J. Dubner?

  Now, is economic decentralisation necessarily a benefit? Cities like New York, London, Paris and Tokyo might argue otherwise.

• 18:31Speaker 10

  There's a large literature that documents that there are returns to density, so bigger cities seem to be more productive. So from that perspective, you know, it may be better to concentrate economic activity in a few large cities.

• 18:47Stephen J. Dubner?

  But density also has its costs: higher housing prices and cost of living, more traffic congestion.

• 18:53Speaker 10

  From that perspective, it may be better to sort of spread economic activity apart.

• 18:58Stephen J. Dubner?

  So is it possible for economists to learn the optimal population distribution across a country's cities?

• 19:04Speaker 10

  The question is a tricky one and one that arguably we have much less of an handle on in terms of understanding. Understanding the full empirics and the importance of different effects. So if we split London into two cities and moved one to the north of England and left one where it is right now, what exactly would be the implications of that for UK economic activity? It'd be great if I could solve that question and provide you with a precise empirical estimate, but it's something that is very difficult.

• 19:38Stephen J. Dubner?

  Okay, fair enough. Hard question to answer. But keep in mind, it also has political implications. A lot of recent elections have seen populist momentum from outside major cities, with voters who feel the cosmopolitan elites don't represent their economic interests.

• 19:54Speaker 10

  If you look at the UK, one of the key obsessions of UK politics is to try and redistribute economic activity away from London to other parts of the UK, which compared to London are lagging. There is spatial inequality in Germany as well, but it's not as extreme with, let's say, Berlin being the vibrant place and everything else being a backwater. So we have a number of cities that also, in terms of per capita income, are very comparable. And maybe this is one of the reasons why Germany has also so far weathered the populist tide.

• 20:33Stephen J. Dubner?

  Maybe, but maybe not. We spoke with Sturm before the recent German elections. Angela Merkel was easily re-elected as Chancellor, but the ruling coalition parties lost seats in Parliament to the Alternative for Germany party. It has an anti-immigrant platform and is especially strong in the former East Germany, where the economy isn't nearly as strong as in the former West, which suggests one of at least two things. The German economic miracle may be running into trouble, or, at the very least, the former East still has a lot of catching up to do, including Berlin itself.

• 21:14Speaker 05

  So I came to Berlin right after the fall of the wall.

• 21:19Stephen J. Dubner?

  That's Dahlia Marine. Today, she teaches economics at the University of Munich. But at the start of reunification, she was at Humboldt University in the former East Berlin.

• 21:29Speaker 05

  And it was a very exciting moment because, basically, you know, under communism, they had not really an economics department. They didn't know anything about Keynes and Adam Smith. Under communism, they basically were teaching Marxism and Leninism. They didn't know anything about the market because they were a planned economy. So they had no alternative then to fire these people.

• 21:57Stephen J. Dubner?

  The firing of communist economists was one of many, many adjustments that came with reunification.

• 22:04Speaker 10

  Reunification was a major economic shock.

• 22:07Stephen J. Dubner?

  Among the problems East Germany faced: a bloated socialist bureaucracy, and dilapidated infrastructure, an unproductive workforce, and massive government subsidies for food and housing. And, oh, yeah, the lack of functional capitalist markets. The German government worked hard to bring East Germany back into the fold.

• 22:28Speaker 04

  And there was a huge economy boom that came with it because there was massive infrastructure investments in the East.

• 22:34Speaker 10

  There were all these enormous transfers paid to try and jumpstart the East German economy.

• 22:42Speaker 04

  There was huge euphoria about reunification. But then, I mean, this mood changed fairly quickly. So 93, 94, maybe, the country really went into a sort of hangover mood.

• 22:54Speaker 05

  Because it was difficult for West Germany to absorb East Germany.

• 22:59Stephen J. Dubner?

  One big difficulty was getting East and West using the same currency, the West German Deutschmark. Jeremyn Zettelmeier says the conversion happened at an even one-to-one rate, which had a huge effect on real wages.

• 23:13Speaker 09

  Now, even though that did not translate into the same wage level in the east as in the west, wages went nonetheless higher than they would have been without that. And so you have a period where effectively the wage levels in the east in hard currency exceed eastern productivity. And that produces more unemployment.

• 23:41Speaker 04

  Just to give you perspective, we had the unemployment rate in Germany in 91 was roughly, you know, 5%. So we had maybe 2 million unemployed people. But then in 97, the whole unemployment rate went up to 11%, 12%. So it was really a dramatic period.

• 24:01Stephen J. Dubner?

  The drama, of course, did not end there.

• 24:04Speaker 09

  And then you have Germany join the euro.

• 24:07Stephen J. Dubner?

  The euro had become the common currency of the European Union. And Germany, unlike Britain, decided to embrace the euro as its currency. Zettelmeier argues that from the German perspective, the euro was overvalued. And that made German exports more expensive, which put a drag on their economy. Beyond that, the new scenario inspired an exodus of German capital.

• 24:33Speaker 09

  And the reason is that investment opportunities in the southern European countries suddenly looked more attractive.

• 24:41Stephen J. Dubner?

  In Spain, for instance.

• 24:42Speaker 05

  There was an extreme capital flight to Spain. And the housing sector in Spain quadrupled. And part of the reason why that happened was because German households, in fact, bought houses in the nice parts of the beach of Spain.

• 24:59Stephen J. Dubner?

  But it wasn't just German households moving their money. Companies did it, too. For years, countries like Spain and Portugal had been cheaper for a company to operate in, but they also came with their downsides: unfriendly business policies, the threat of high inflation, the occasional currency crisis. But now, as fellow EU nations using the common euro currency, Germans took a second look.

• 25:24Speaker 09

  It was almost like having these countries sign up to this kind of fitness plan. And that made them very attractive.

• 25:32Stephen J. Dubner?

  Manufacturing in Germany, therefore, became less attractive. And that made unemployment even worse. So if you add up all these factors, some subtle and some quite blunt, you can see why Germany by the early 2000s was not in great economic shape.

• 25:49Speaker 04

  You really had the impression that the German economy is about to fall off a cliff or something. And that's where this famous expression of the sick man of Europe was coined by The Economist.

• 26:03Stephen J. Dubner?

  Coming up on Freakonomics Radio, so how did the sick man of Europe turn into the economic stud we see today?

• 26:10Speaker 04

  You know, at first glance, I mean, the system looks pretty inflexible and rigid.

• 26:15Stephen J. Dubner?

  It's coming up right after this break.

• 26:33Stephen J. Dubner?

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• 27:17Stephen J. Dubner?

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• 27:35Stephen J. Dubner?

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• 28:19Stephen J. Dubner?

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• 28:40Stephen J. Dubner?

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• 29:14Stephen J. Dubner?

  It's no secret that the German economy is booming right now.

• 29:18Speaker 11

  The country is the economic engine of Europe with enviable numbers on public and private debt, productivity growth, and unemployment. This week, Germany also announced a record trade surplus.

• 29:29Speaker 12

  We Germans have 1% of the labor force of the world, and we have 10% of the exports of the world.

• 29:35Stephen J. Dubner?

  But just 15 years ago, things were looking pretty grim. The country was struggling to reunify after the Cold War. Adopting the euro had its downsides, including a flight of German capital from Germany. And unemployment was at nearly 12%.

• 29:49Speaker 04

  The talk shows, they were full of people arguing that Germany is not competitive. Wages are too high. The labor market is too inflexible. The social security system is too generous. And we have to do something dramatic about it.

• 30:04Stephen J. Dubner?

  That, again, is the University of Dusseldorf economist Jens Sudakum.

• 30:08Speaker 04

  So basically, you can really think of that period from 93 till 2003 really as a decade of stagnation. So that was the mood that predated the Hartz reforms in 2003.

• 30:21Stephen J. Dubner?

  The Hartz reforms were named after Peter Hartz, a Volkswagen executive who became an adviser to Chancellor Gerhard Schröder. Schröder and his Social Democratic Party had been elected to lead Germany in 1998.

• 30:33Speaker 04

  There was this impression that if somebody can reform the country, it's going to be them, right? Because they are social democrats, they have the unions on their side, right? And so 2003, Schröder announces what he has called the Agenda 2010, and the famous Hartz reforms, they were part of this agenda.

• 30:51Stephen J. Dubner?

  Among other changes, the Hartz reforms lowered government assistance to the poor and unemployed, made it easier for firms to fire employees, and encouraged more part-time, low-wage, non-union jobs. As you can imagine, such reforms did not make Schröder universally beloved.

• 31:10Speaker 04

  And it had a huge political cost because he lost the left-wing part of the social democrats. And basically, it cost Schröder the chancellorship, so he lost the election in 2005 to Angela Merkel. But then ultimately, the common narrative is basically those Hartz reforms, they created the turnaround.

• 31:30Stephen J. Dubner?

  That, at least, is the common narrative. Some economists think it's more nuanced than that, that there are more factors to consider. Let's start with Germany's unique system of labor relations.

• 31:41Speaker 04

  You know, at first glance, I mean, the system looks pretty inflexible and rigid.

• 31:45Stephen J. Dubner?

  And unusual in at least one other way, German manufacturing is not dominated by gigantic firms.

• 31:52Speaker 05

  So one of the distinctive features of the German manufacturing sector is you see all these small and medium sized firms.

• 32:01Speaker 09

  Germany is fairly unique in having companies with between a few hundred and maybe a thousand employees that do a lot of exporting.

• 32:13Stephen J. Dubner?

  Such firms are often family owned and typically receive government support. Collectively, they're known as the Mittelstand.

• 32:20Speaker 05

  The interesting thing is that normally when you have small and medium enterprises, they are not international. The major thing about the Mittelstand in Germany is that they are very international. I'm talking here about the export superstars.

• 32:34Speaker 04

  I mean, you have all these so-called hidden champions in Germany. So these are medium sized firms, often located somewhere in the countryside, but they are kind of the world market leader for some very specific niche product where they offer the highest quality.

• 32:49Stephen J. Dubner?

  Products like pipe organs, or battery chargers, or professional movie making equipment, or fish processing machinery.

• 32:58Speaker 04

  And the workers of these firms, I mean, they're highly paid, they're protected, and the unions there, the work council is important there.

• 33:04Stephen J. Dubner?

  A work or works council is like a trade union writ small, sometimes representing the workers of just that one firm. And it participates in decision making with the firm's executives. It's part of a system known in German as.

• 33:20Speaker 05

  Mitbestimmung, yes. Code determination. This is a very important part of the way Germany is doing business.

• 33:28Stephen J. Dubner?

  So the governance of firms, small and large, is not determined solely by executives and big shareholders, but with input from the workers themselves. That goes for factory decisions and boardroom decisions. Uwe Reinhardt again.

• 33:45Speaker 06

  In Germany, the unions have representatives on the board of the company, like Siemens or Mercedes. They probably have two or three union bosses sitting on the board.

• 33:58Stephen J. Dubner?

  This setup gives workers more leverage over employment policies. Including wages.

• 34:03Speaker 04

  I mean, the the system of industrial relations in Germany is, you know, that there is wage negotiations at the industry level, right? So here's the union, here's the employer association for each industry. So they sit together, they bargain a wage, and that wage is basically applied everywhere in the country in that industry.

• 34:20Stephen J. Dubner?

  Kind of the way sports leagues work in the US, at least to some degree.

• 34:24Speaker 04

  That's the rule, but there are exceptions.

• 34:28Stephen J. Dubner?

  One big exception is known as an opening clause.

• 34:31Speaker 04

  So that means at the firm level, if the work council agrees, it is possible to deviate from these arrangements under certain well-specified circumstances. And I think that's important. The employer, basically, the firm, has to prove that this downward deviation is really necessary to prevent, for example, a bankruptcy or, you know, to to remain competitive. They really have to make sure unless we we have this flexible wage setting, we really have a fundamental problem and we may have to fire workers.

• 35:05Stephen J. Dubner?

  You may be surprised to learn that German workers willingly accept a wage lower than the one their union negotiated. But they learn from history, specifically from their own history at the end of the Cold War.

• 35:18Speaker 05

  With the opening up of Eastern Europe, firms would threaten to go to Eastern Europe.

• 35:24Speaker 04

  This threat of production relocation to Eastern Europe. So the firms kind of realized that they need to restructure, they need to become competitive.

• 35:33Speaker 05

  And that threat actually brought a big change in the way wage bargaining was organized.

• 35:41Stephen J. Dubner?

  Specifically, a heavier reliance on opening clauses.

• 35:45Speaker 05

  And so the individual firms could adjust more flexibly to the circumstances that the individual firm was facing.

• 35:54Speaker 04

  And I think what's very important that the unions in Germany, that they were cooperative, right? So the unions, in principle, they could have just say, no, we're not willing to cooperate, right? And we just, you know, try to achieve the maximum that we can for our members, right? But I think the unions, they deserve quite some credit for being flexible and being willing to cooperate.

• 36:16Stephen J. Dubner?

  So here's a question. How well would this cooperative labor model travel? The German auto firm Volkswagen found out a few years back when it opened a factory in Chattanooga, Tennessee. By the way, this was before VW's emissions scandal or the accusations of collusion between VW and other German carmakers, which, by the way, if you're even a little bit cynical, you might think could help explain a good bit of the German economic miracle, since cheating and winning do often travel in the same direction. But that's not the story we're telling right now. The story we're telling right now is about when VW came to Chattanooga to make cars.

• 36:58Speaker 13

  VW's German ownership has made it clear it wants a German-style works council that involves workers and management at the Chattanooga plant to negotiate employee concerns. Both the United Auto Workers Union and the American Council of Employees Union have both come up with plans to work through their versions of a German-style works council. That type of labor agreement would be historic in this country.

• 37:21Stephen J. Dubner?

  So far, so good. The labor unions were up for copying the German model, but Tennessee's political leadership, which historically has not been union-friendly, did not like this idea one bit.

• 37:33Speaker 14

  Senator Bob Corker says Volkswagen would become a laughingstock if it partners with United Auto Workers. Corker called it incomprehensible that Volkswagen management invited UAW for discussions. And he's not the only one upset. Governor Bill Haslam says discussions with UAW have hindered business recruitment in Tennessee.

• 37:54Speaker 15

  There is no question that if the UAW comes in there, it will impact our ability to recruit out of business in Tennessee.

• 38:01Stephen J. Dubner?

  The plan was ultimately ditched. The Princeton economist Uwe Reinhardt says that considering the recent history of American auto manufacturing, including its bankruptcies, these politicians' concerns about American labor unions may not be unfounded.

• 38:16Speaker 06

  Well, the way I put it to the freshmen at Princeton is a business firm is really just a little bowl into which Tender Vittles are poured.

• 38:25Stephen J. Dubner?

  Tender Vittles, in case you don't recall, was a brand of, quote, "semi-moist cat food" that cats allegedly went crazy for. Tender Vittles cat food says, "Fresh to your cat at every meal."

• 38:37Speaker 06

  Fresh.

• 38:39Speaker 06

  So I always use that as a metaphor for businesses. You know, I mean, the customers pour in the Tender Vittles. And in the US, when you had a union, they would fight and spill the whole bowl of Tender Vittles. And in the end, no one could eat anymore. When I looked at UAW, it's insane. They're going to kill their company. And sure enough, they damn near did. I mean, General Motors was almost bankrupt. In Germany, the unions have representatives on the board of the company. And yes, they view and say the first thing that this bowl of Tender Vittles, we have to make sure that the bowl is there.

• 39:24Speaker 06

  We can fight all we want, but don't spill the bowl. So you don't destroy your company. And that was not the attitude of Anglo-Saxon unions, either in England or in the US.

• 39:36Stephen J. Dubner?

  Some economists, Dalia Marine, for instance, think that a work council can bring together unions and firms anywhere.

• 39:43Speaker 05

  Yeah, I think it's an institutional arrangement that can be, in principle, replicated in other countries.

• 39:50Stephen J. Dubner?

  Or maybe Germany is simply different. Gen Sudeckum again.

• 39:55Speaker 04

  Yeah, I think culturally, I mean, there is a sense of you have to be flexible, you know, when circumstances change, when new challenges arise. I think this is kind of deeply embedded in the German approach of doing things.

• 40:10Stephen J. Dubner?

  Even Dalia Marine doesn't disagree with this.

• 40:12Speaker 05

  It's true. It's part of the culture. You try to come to a common goal. This has a high value. Germany is a stakeholder economy in that sense. Yeah, it's not a shareholder economy. It's a stakeholder economy.

• 40:29Stephen J. Dubner?

  This culture, Maureen says, also manifests itself in management style. Her research has shown that German CEOs are more willing to grant decision-making power to lower management. And that, she argues, improves quality, because those are the managers who have the best sense of what customers want. This requires CEOs to have quite a bit of faith in their managers.

• 40:53Speaker 05

  And that is part of a cultural thing, that people trust each other.

• 40:58Stephen J. Dubner?

  An earlier episode of Freakonomics Radio called "Trust Me" explored an important, but often overlooked, element of successful societies. It's called social trust.

• 41:09Speaker 16

  It's just one of those things. It's sort of like the dark matter of the economy and society matters very greatly, and yet we don't seem to focus on it very much.

• 41:18Stephen J. Dubner?

  And on the standard measures of social trust.

• 41:21Speaker 05

  You see, Germany comes out very high.

• 41:24Stephen J. Dubner?

  Not quite as high as the Scandinavian countries, but well ahead of the US, France, Italy, Spain, England. And in Germany, trust has been increasing lately, unlike most of those other countries. Whatever the causes, the fact is that German firms enjoy a relatively harmonious relationship with their workers, which can come in handy when you're facing a big external threat, like China.

• 41:50Speaker 04

  I think that sort of arrangement made Germany kind of ready for globalization, made it kind of competitive when globalization really kicked off at the turn of the millennium.

• 42:00Stephen J. Dubner?

  That, Jen Sudakum points out, is when China joined the World Trade Organization.

• 42:05Speaker 04

  I mean, that's the time when trade between Germany and China really went through the roof. I mean, now, as of 2017, China is the biggest trading partner of Germany.

• 42:15Stephen J. Dubner?

  It's not that Germany didn't experience any of the labor contraction that hit the US and other countries.

• 42:21Speaker 04

  It's just that we had more offsetting positive effects in other communities and other industries.

• 42:26Stephen J. Dubner?

  Offsetting positive effects driven by a seemingly insatiable Chinese appetite for German-made goods.

• 42:34Speaker 04

  Luck is one part of the story, right? So we just happened to produce the type of stuff that China Wanted and China needed.

• 42:41Stephen J. Dubner?

  Stuff like the specialized machinery made by all those Mittelstand companies and stuff like high-end cars, BMWs, Audis and Mercedes-Benzes.

• 42:50Speaker 04

  I mean, German engineering is kind of legendary and German machinery is legendary. So that's one part of the story.

• 42:56Stephen J. Dubner?

  But the other important part of the story is that German manufacturers already had practice staring down the threats of globalization. They were lean and mean and they'd built a collaborative culture and institutions that prized flexibility. Here's Zettelmeier again.

• 43:14Speaker 09

  It is true that the success of Germany in export markets is a national prerogative, that so many jobs depend on them. And so as a result, you tend to have unions, both at the company level and sector unions, that are happy to prioritize competitiveness over wage increases.

• 43:39Stephen J. Dubner?

  To be fair, Germany has seen a decline in manufacturing as a share of GDP.

• 43:45Speaker 04

  But our work really showed that globalization and trade actually contributed nothing to this manufacturing decline. So the manufacturing decline is driven by other channels. So technology can be robots, it can be automation, but it's not trade. It's not globalization.

• 44:02Stephen J. Dubner?

  Sudakum's research, in fact, shows that globalization helped Germany retain manufacturing jobs.

• 44:08Speaker 04

  If you do a net calculation, we have a plus of maybe half a million jobs.

• 44:13Stephen J. Dubner?

  Compare that to the loss of over a million manufacturing jobs in the US just from trade with China. But as Sudakum points out, workers everywhere are now facing competition from robots and computers. And yet, even in this realm, German labor has so far been resilient. In a new paper, Sudakum and his colleagues find that, quote, "Robots have not been major job killers in Germany so far, somewhat in contrast to the buzz in some of the contemporary public debate." Granted, this has been achieved in part by wage cuts, but once again, the German system of industrial relations has proven adaptive.

• 44:55Stephen J. Dubner?

  It has also been proven durable. There are a lot of longstanding labor practices in Germany that seem to produce systemic benefits. For instance, its famous system of apprenticeship, which is funded by both the government and the private sector.

• 45:09Speaker 04

  I mean, the system of apprenticeship is really one of the biggest advantages that Germany has, especially for manufacturing.

• 45:15Speaker 09

  The apprenticeship system ensures a flow of relatively talented young people into industry that might not even consider industry in other countries.

• 45:26Speaker 04

  We're talking about kids who don't go to college. So in many other countries, they would just pick up the job somewhere and start working and receive on-the-job training for one firm, right? So in Germany, you go through the system of vocational training, right? So basically, half of the week, you work for one employer, right? And the other half of the week, you go to school and receive some general training. And I think the biggest advantage of that is that the workers acquire something that we economists call not just firm-specific, but industry-specific or occupation-specific human capital, right? And I think that helps you to adapt when your employer goes broke and you just need to find a new job, then I think you fare much better.

• 46:06Stephen J. Dubner?

  It's this kind of institution that may explain why Germany weathered the 2008 financial crisis and subsequent euro crisis relatively well. It saw only a small rise in unemployment. The German system of co-determination also helped. Here's Dahlia Marine again.

• 46:23Speaker 05

  So there was a big bargain between the government and the entrepreneurs and the unions. The firms will keep the workers, in particular, the skilled workers, and will get a subsidy for keeping them from the government.

• 46:41Stephen J. Dubner?

  And the financial crisis actually strengthened Germany's position in the EU, at least on one dimension: currency. You'll remember that Germany was initially punished for embracing the euro in that its exports got relatively expensive, but now it stood to benefit. German Zettelmeier.

• 46:59Speaker 09

  In some sense, German competitiveness is the flip side of a lack of competitiveness in other countries that are part of the same currency union. Imagine what would happen if we exited the euro, right? So the currency would appreciate, the new deutsche mark would be much stronger, and what that means is that in dollar terms, German industrial wages would be way higher.

• 47:25Speaker 09

  Now, we are in the euro that is keeping the German currency undervalued, so to speak, because the value of the euro, even though there is no interference through intervention, no currency manipulation whatsoever, we are in the same currency as countries for whom the euro is rather strong, you know, like some of the Mediterranean countries. So that lack of competitiveness in the South is holding back the value of the euro as a whole, and that increases the surplus.

• 47:56Stephen J. Dubner?

  The surplus, meaning the trade surplus, that makes up a big part of what economists call a nation's current account.

• 48:02Speaker 09

  So, you know, many people, to a first approximation, think of it as the trade balance, which is just basically the value of goods that you export minus the value of goods that you import. But that's a little too narrow. Investment income is also in there, which is actually quite big in Germany. So it's not all about just the trade balance.

• 48:25Stephen J. Dubner?

  What is the state, then, of Germany's current account?

• 48:29Speaker 09

  The German current account is the biggest in the world in absolute terms.

• 48:33Stephen J. Dubner?

  In 2016, it hit a record high of nearly $300 billion, more than China's, which has more people and a bigger economy. As a former government official, Zettelmeier confirms that Germany's record surplus is a major source of pride.

• 48:48Speaker 09

  There was certainly the prevailing view that we have a big surplus because everyone loves our products, including ourselves. So, you know, everyone just wants German stuff. And so this is why we export a lot, and we want German stuff too, which is why we tend not to import so much. We just buy our own things.

• 49:07Stephen J. Dubner?

  This means that other countries may see a big trade deficit with Germany, which doesn't necessarily make them happy.

• 49:14Speaker 17

  President Donald Trump is criticizing Germany again. This morning, German magazine Der Spiegel reporting the president sharply criticized Germany in a meeting with European Union officials, lashing out, saying, "The Germans are bad, very bad. Look at the millions of cars they are selling in the US. Terrible," according to participants there.

• 49:34Stephen J. Dubner?

  But it's not just Trump. Other EU nations have argued the same thing, as has The Economist. Germany, they say, is making tons of money selling its goods around the world, but it doesn't use that money to buy other countries' goods. It's a criticism that Zettelmeier does not completely dismiss.

• 49:51Speaker 09

  Even if, you know, it's true that people just love our products, you know, we are so great, BMWs are fantastic, so we are awash in cash. You know, normally, a country should then be spending this cash. And, you know, maybe if we don't like, whatever, US cars, maybe we don't spend it on US cars. But, you know, surely, there are very nice holidays in the US. Surely, there are services that we can buy from abroad. So, you know, there is a general puzzle as to why a country would not actually spend these export proceeds.

• 50:30Stephen J. Dubner?

  There is another way Germany could shrink that surplus. Firms could give their workers a big raise.

• 50:37Speaker 09

  And so here is the slightly weird thing about Germany, that we have a labor market set up that was, you know, critically shaped by a period when Germany was not very competitive. And somehow, this continues to function as if the biggest problem in Germany is to maintain its competitiveness, when that's actually not true, right? We are very competitive, and so we could let wages go up. But there is a very large degree of caution among the unions and the employers that prevents this from happening.

• 51:16Stephen J. Dubner?

  That caution hasn't stopped the German government from acting.

• 51:19Speaker 09

  Even though it wasn't billed as, you know, let's try to reduce the current account surplus, let's try to reduce Germans' hyper-competitiveness, we have done a lot in this government to raise wage levels.

• 51:33Stephen J. Dubner?

  But this is not happening primarily in the high-wage manufacturing sector.

• 51:38Speaker 04

  I mean, one impression of of German labour market is, you know, these these well-paid, highly-protected jobs in the manufacturing industry, right? But on the other end of the spectrum, I mean, you have a huge, huge low-wage sector in Germany, actually one of the largest low-wage sectors in Europe. And the Hartz reforms, they expanded this low-wage sector, which is completely uncovered by union agreements and until recently wasn't even subject to a minimum wage. So, I mean, we had people working for as little as three euro fifty, so basically maybe less than five dollars an hour.

• 52:17Speaker 09

  And so the current government has actually done quite a lot to raise wage levels. So one was we have introduced a statutory minimum wage in several stages in 2015 and then this year, so it's now fully there. It is also reasonably high, so it is higher than in terms of how it affects the wage distribution than in the United States, for example. We also have done a bunch of legislation that essentially strengthens unions. You know, part of the problem is that the services sectors, they don't lend themselves to unions much, or at least, you know, historically, unions have been weaker there.

• 52:55Speaker 04

  And, yeah, you have many immigrants working in the sector. You have, especially in East Germany, that sector is very active, right? And where kind of all these nice arrangements that you hear about, when you hear about German manufacturing sectors, they just don't apply to that sector of the economy.

• 53:10Speaker 09

  And so there's been some legislation to strengthen unions, particularly big unions, majority unions. But, you know, the next big step would involve changing the labour market constitution fundamentally. I mean, taking away the so-called autonomy of wage setting from employers and unions, and that we are certainly not going to do, right? So that's, that's basically a good institution. And so if you're really serious about wage increases in Germany, at this point, the only way you can do it is through public sector wages. So the public sector is quite large. And, you know, the government can raise public sector wages. Why not?

• 53:49Stephen J. Dubner?

  While Zettelmeier supports the idea of potentially spending down Germany's account surplus, he notes there may be one good reason to proceed cautiously. The economist Daniel Stern expressed the very same caution.

• 54:02Speaker 10

  So Germany's birth rate is about 1.5 children per woman. These are birth rates that are below the European average and mean that population in Germany is going to shrink for the foreseeable future and is going to do so at a fairly dramatic pace.

• 54:21Stephen J. Dubner?

  That means fewer young people to work and more old people to collect benefits. One potential solution, of course, is more immigration. Chancellor Merkel's recent decision to accept roughly a million refugees from Syria, Iraq, and elsewhere was a controversial one. Again, witnessed a strong showing by the Anti-immigrant Alternative for Germany party during the recent elections.

• 54:46Speaker 10

  Unless you wanted to accept sort of a million people a year, which would certainly politically be completely unacceptable even in Germany, you cannot compensate for such a shortfall of birth rates through in migration.

• 55:03Stephen J. Dubner?

  All that said, when one of your country's biggest economic problems is whether its surplus is too large or whether it is too competitive on the world stage, well, a lot of countries would love to have your problems. So we couldn't help but ask this crew of German economists we've been speaking with today, what lessons, if any, the US should take from the German success? First, the spatial economist Daniel Stern.

• 55:32Speaker 10

  I guess one of the most important lessons is that training workers, and particularly training workers at the lower end of the skill distribution, is key to increasing productivity and also, I think, to increasing social cohesion, a feeling of belonging and contributing, that it's not just, you know, the top 20% that are highly successful. But their success is spread throughout the workforce and that there is training for different types of people, for different types of occupation, and all of those are really valued and are important contributions to the economy.

• 56:08Stephen J. Dubner?

  Next, Jens Sudikum from the University of Düsseldorf.

• 56:12Speaker 04

  I mean, we also had these losers of globalization here in Germany, so people who have really had problems because of trade, right? But I think a big difference is in Germany, these people receive more support from the government. So there is a safety net, there is trade adjustment assistance, there is kind of active labor market policy, trying to bring these people back to other jobs elsewhere, and subsidies, just trying to keep the communities alive, right? And I think we do a relatively better job in kind of cushioning the losers. I'm not saying we're perfect in that, but I think we are doing a better job than the United States.

• 56:53Stephen J. Dubner?

  Jermaine Zettelmeier, the former government official, thinks it would be hard to simply transfer Germany's labor relations infrastructure to a country like the US.

• 57:02Speaker 09

  For example, unions play a big role in the German model. In the US, unions are just not that strong. So, you know, we can always say, oh, well, one of the lessons is you should, A, increase the role of unions, and B, make them very reasonable and very cooperative, like the German ones, you know? But we wouldn't even get through stage A of this.

• 57:25Stephen J. Dubner?

  Zettelmeier points out that the German model has plenty of its own problems. For instance, an emphasis on tradition, perhaps at the expense of innovation.

• 57:34Speaker 09

  So the German industry is very much geared towards helping incumbents do well. It's, you know, the unions are supportive, the state is there to lend you a hand. So we have a very generous supply of credit from, you know, specialized banking segments that specifically lent to mendelstand companies. We have

• 57:59Speaker 09

  Lots of barriers to labor mobility in Germany, so there are very high hiring and firing costs. So the typical churning that you get in an economy is lower. And that's, you know, arguably a good thing in the sense that we have good companies and that make good products and have good jobs that are preserved. But it also has a bad side, and that bad side is simply not visible, which is we are preventing the growth of, say, you know, impressive companies in new sectors, right? It's not a very dynamic economy.

• 58:30Speaker 05

  Yeah, it's true.

• 58:32Stephen J. Dubner?

  That's Dahlia Marine from the University of Munich.

• 58:35Speaker 05

  So you don't have these big high-tech firms like Google, Facebook, Amazon, and so on. Germany doesn't have that. There are some, but very few.

• 58:46Stephen J. Dubner?

  Even Germany's world-beating auto sector, she says, is vulnerable.

• 58:50Speaker 05

  And so one problem today is how is the car industry going to do in the future when you have these autonomous cars? The cars become more computer and software than hardware. But the advantage of German carmakers was the hardware and not the software. Will Germany survive this threat? Because that's not where the comparative advantage in Germany is.

• 59:21Stephen J. Dubner?

  The U.S., meanwhile, has had its own comparative advantage. And Jermaine Zettelmeyer argues that this has had the unfortunate side effect of wounding its manufacturing sector.

• 59:34Speaker 09

  A very, very important reason why manufacturing has declined, at least traditional manufacturing has declined in the U.S., which is completely underemphasized, particularly by the Trump administration, is domestic competition. So extremely dynamic growth in

• 59:53Speaker 09

  New sectors in the United States, particularly, of course, the computer industry and the software industry, the platforms, the IT giants. And this growth sucks away labor and makes it harder for traditional companies to compete. So this has nothing to do with globalization. This has something to do with technical change, but it has a lot to do just with the general dynamism of the US economy. And one of the reasons why the manufacturing share is high in Germany is because the German industry lacks this dynamism. The US has traditionally been a much more dynamic economy. I think the US has a very good model.

• 1:00:34Speaker 09

  And what the US should focus on is to maintain and improve its model, not about copying the German one.

• 1:00:45Stephen J. Dubner?

  Coming up next time on Freakonomics Radio, there's one autoimmune disease that's different from the rest.

• 1:00:52Speaker 18

  Because the culprit, the enemy, that turn on the immune system to attack your own body is known, and that's gluten.

• 1:01:00Stephen J. Dubner?

  The disease, as you likely know, is celiac disease. The story of how it was discovered, how it was until recently vastly underdiagnosed, at least in the US, and how it has led to a mass gluten-free movement that often has nothing to do with celiac disease. There was a sort of perfect storm of celebrity endorsements, other fad diets, and a foundation of anti-carbohydrate bias that set the stage for gluten-free to take off. Gluten, gluten everywhere. That's next time on Freakonomics Radio.

• 1:01:37Stephen J. Dubner?

  Freakonomics Radio is produced by WNYC Studios and Dubner Productions. This episode was produced with great skill and insight, I must say, by Greg Rosalsky. Our staff also includes Alison Hockenberry, Merritt Jacob, Stephanie Tam, Eliza Lambert, Emma Morgenstern, Harry Huggins, and Brian Gutierrez. The music you hear throughout the episode was composed by Luis Guerra. You can and should subscribe to Freakonomics Radio on Apple Podcasts, Stitcher, wherever you get your podcasts. You should also check out our archive at Freakonomics.com, where you can stream or download every episode we've ever made, more than 300. You can also read the transcripts and find links to the underlying

• 1:02:17Stephen J. Dubner?

  research. We can also be found on Twitter, Facebook, or via email at [email protected]. Thanks for listening.

• 1:02:34Stephen J. Dubner?

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