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Looking beyond COVID, Chancellor Olaf Scholz’s government must reinvent the German economy.

Labor market and social welfare reforms championed by Gerhard Schroder in 2003 unleashed market forces that made possible Angela Merkel’s growth and prosperity. One built on superior industrial engineering, manufacturing excellence and exports of autos, industrial machinery, robots and other engineering products and services to China and America.

Now climate change, electrification, and the rise of China challenge all that.  

Gasoline-powered cars

The south is profoundly dependent on the internal combustion engine automobile. Daimler DAI, -0.86%, Volkswagen VOW, -0.83% and BMW BMW, -0.73% have the resources to make big bets to catch up with Tesla TSLA, -0.50%. They have the heft that electric vehicle startups lack—large assembly plant networks to meet Scholz’s goal of putting 15 million EVs on the road by 2030 and similar ambitions elsewhere in Europe and America.

However, the pyramid of smaller suppliers that make pistons, tailpipes and other internal combustion engine components are not so well placed. EVs contain many fewer moving parts, those companies’ suppliers often lack expertise in software and microelectronics appropriate to EVs, batteries account for about 40% of EV cost, and China controls the lion’s share of cell manufacturing.

China’s Contemporary Amperex Technology, Ltd. 300750, -1.62% is building a massive German plant to supply European auto makers. Bosch, the world’s largest automotive supplier, won’t build batteries for EVs but instead will cooperate with CATL. Consequently, significant royalties and profits that fund new product development will flow to a Chinese, not German, company.

German firms that bore tunnels and help build mass transit systems world-wide are losing market share. Now, Chinese firms are digging tunnels for the Stockholm Metro and supplying railcars in Portugal. Also buses in Norway, wind turbines in France, and power grids in Poland.

Fiscal challenges

With all this, creating enough new good-paying jobs will be much tougher for Scholz than it was for Merkel, yet he is raising the minimum wage from €9.60 to €12. If nothing else, that will grow the market for industrial robots and artificial intelligence software.

Scholz’s coalition government plans to increase public spending on R&D—the best way to leverage private innovation and entrepreneurs—but the new government aims to get Germany out of coal by 2030 and construct 400,000 new homes annually to address shortages and affordability.

After the 2011 Fukushima nuclear accident, Germany abruptly decided to phase out nuclear power and the country already uses too much Russian gas—imposing national security vulnerabilities and constraining foreign policy.

Scholz’s environmental goals require massive investments in wind and solar power. Here Scholz’s problems look too much like those of an American president.

High costs

Investments in green power may create more externalities for the competitiveness of domestic industries but Germany already has the highest electricity rates in Europe. Scholz can’t easily push its utilities to borrow, modernize and pass along the costs without industry screaming.

The regulatory bureaucracy annually costs businesses about €55 billon. That’s about 1.6% of GDP and more than Germany spends on national defense.

Michael Mann, an entrepreneur in western Germany, built wind turbines three decades ago about 30 miles from the largest town—government approval took three months at a cost of €5,000 at current prices. More, recently, he sought approval to replace those with new turbines that would generate 40 times as much energy—approval took seven years and almost €300,000.

Germany lacks an adequate grid to transfer wind power from the north to the industrial south but construction of power lines has been blocked by legal challenges from not-in-my-backyard protesters.

Scholz and his coalition partners want to slash regulatory approval times, and the Greens’ co-leader, Robert Habeck, has been appointed minister for the economy, climate and energy. He earned his progressive chops campaigning for bike paths, writing children’s books and as environmental minister in Schleswig-Holstein. It will be interesting to watch him try to dismantle the morass of obstacles and confront the bureaucracies and legal barriers.

Germany’s national debt is lower than other major European states, so it can afford to borrow to invest in a brighter future.

However, the necessary support of the conservative Free Democratic Party for Scholz’s coalition was obtained by ceding control of the finance ministry. The FDP managed to extract a pledge of continued budget discipline—no outsize borrowing and no new taxes, except those to curb CO2 emission.

Scholz’s platform is exquisitely balanced to accomplish a three-party coalition but the political and fiscal constraints may require a magician more than a statesman to accomplish the economic transformation Germany—and Europe—need.

Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.

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