Achim Wambach: Revival of industrial policy in Germany

President
ZEW – Leibniz-Centre for European Economic Research
Germany

Germany has long advocated for an economic policy model in which the state sets the rules but does not intervene directly – the social market economy. As the first Minister of Economic Affairs of the Federal Republic of Germany, Ludwig Erhard, phrased it in a speech to the European Parliament in 1962: “What we need, in my opinion, is not a planning programme, but a regulatory framework.”

These times are long gone, if they ever even existed. Already in past decades, the German government supported numerous firms and industries directly. But the scope of state intervention has increased recently. State aid has grown from about €26 billion in 2000 (0.8% of GDP) to €74 billion in 2022 (1.9% of GDP). For comparison: In the EU, state subsidies rose from around €97 billion in 2000 (0.7% of GDP) to €228 billion in 2022 (1.4% of GDP).

Subsidies in times of crisis

A significant part of these company subsidies was crisis-related. Starting with the 2008 financial crisis, when banks and companies received liquidity support, financial assistance surged during the COVID-19 pandemic and peaked with the “Doppelwumms”, a phrase coined by Chancellor Olaf Scholz for the economic stimulus package during the energy crisis 2022. At the European level, this prompted complaints, e.g. from Vice President Vestager, who argued that Germany was giving its firms an unfair advantage, since other countries could not afford such generous programmes. However, this criticism overlooks that German companies helped to fund these subsidies through some of the highest corporate tax rates in Europe.

Subsidies for economic transformation

Supporting firms in navigating the economic transformation towards decarbonisation has become one of the new rationales for industrial policy, alongside more traditional goals, such as funding research and development and providing regional support. Such measures should however be seen in the context of the EU Emissions Trading System, which puts a price on harmful emissions. This reduces the need to subsidise green investments, as they become self-financing when the fossil fuel counterpart becomes more expensive.

Yet, in the absence of a global CO₂ pricing system, and with the Carbon Border Adjustment Mechanism providing only limited protection for European companies against unfair competition, it may be necessary to help industries make the transition. The German government is accomplishing this with the KTF – the Climate and Transformation Fund. Companies receive Carbon Contracts for Difference, which pay the difference between the current CO₂ price and the CO₂ price necessary to make the green investment profitable. In the first bidding round for these contracts, €4 billion was available, which was oversubscribed by the applications from around 20 large and medium-sized companies. The next bidding round, which is currently underway, is set at €19 billion. It is advantageous to auction off these subsidies, as the goal is to transform an industry, and not necessarily every company in the industry.  While the contractual structure has its merits, it also insulates companies from movements in the price of CO₂. This might lead to inefficient investments, since the price of CO₂ is the main allocation tool for green production and investment. A better solution would be to use green lead markets instead. For example, requiring cement users to use 10% green cement, with increasing levels over time, would create a market for green cement. Firms that invest in green cement could thus capitalise on their investments without the need for subsidies.

A resilient economy

The supply chain problems during the COVID crisis and Russia’s interruption of the gas supply have put supply chain security and resilience on the agenda of industrial policy. Germany supports the European Raw Materials Act and is involved in international negotiations to ensure better access to raw materials.

One instrument for more supply chain security is the use Pandemic Preparedness Contracts, which the German government established after the COVID crises. With these contracts the government subsidises pharmaceutical firms such as BioNTech to develop vaccine production capacity in Germany, at an estimated cost of around €3 billion by 2029.

The European Chips Act, with €20 billion of German funding allocated to major companies such as Intel (€10 billion), TSMC (€5 billion), Infineon (€1 billion), and ZF/Wolfspeed (€600 million), is often cited as another measure to boost resilience. However, there are doubts about its effectiveness. First, economic theory suggests that potential supply chain problems are more effectively tackled at the beginning of the chain rather than at the end or in between. Second, the subsidies were originally proposed to reduce dependence on Taiwan. However, the US, through its CHIPS and Science Act, launched a substantial $280 billion subsidy programme, of which over $70 billion is earmarked for the chip industry, which reduces the need to locate chip industries in Europe for geostrategic reasons. Meanwhile, Intel and Wolfspeed have announced that they are postponing the construction of their factories.

How to adapt the regulatory framework of the social market economy to today’s challenges with regard to decarbonisation and resilience will be the most important task for German economic policy in the years to come.