The US election was dominated by two non-conventional candidates which were deeply uncomfortable with the economic status quo. Bernie Sanders basically wanted to create a US capitalism with a human face, so to speak.
That is, extending the welfare state and public investment in research, education and infrastructure. The short-hand view for that has been to turn the US into Denmark.
Now, there is little wrong with Denmark, as one of the Nordic countries which consistently score very high on stuff like inclusive growth, happiness, social development indicators, low incidence of corruption, and economic innovation. But turning the US into it, well, good luck to that.
It is less obvious what economic role model country Donald Trump had in mind as the totality of his economic view doesn't seem to add up to a coherent worldview. He wants to bring jobs back, which according to him have been moving abroad as the result of terrible trade deals and he has a distinctly protectionist bend.
He also wants to keep much of the welfare state (stuff like Medicare and Social Security) intact and although he has vowed to repeal the ACA, he promised to replace it with something better that covers all Americans. Then there are (rather vague) plans for an infrastructure bonanza.
All of this is in fairly stark contrast to the usual economic platform of the party which nomination he won. The Republicans are the party of small state, deregulated capitalism and they want to either privatize or cut much of the welfare state.
This fault line seems to be a bit of a clash also in the markets, which alternates between going all-in on the tax cuts/deregulation meme but then getting frightened with when the protectionists instincts resurface.
The question is justified, what inspires the 'bad' Trump, is there a philosophy behind that part which seem to spook the markets from time to time? Here is Trump's trade adviser Peter Navarro (from Business Insider our emphasis):
"We envision a more Germany-style economy, where 20 percent of our workforce is in manufacturing," Navarro told CNBC in a recent interview. "And we're not talking about banging tin in the back room." Again, yes the US economy is the envy of the world for its high-tech sector and services sectors, but that isn't to say that we don't have a manufacturing sector at all. In 2014, the International Monetary Fund calculated that if the US manufacturing sector stood alone, it would be the eighth-largest economy in the world.
Indeed, Trump and much of his team have lamented the decline in manufacturing jobs and surprising wins in a number of rust-belt states is what brought Trump the Presidency.
But how would one create a more German-style economy with 20% of the workforce in manufacturing? Well, the first question that bubbles up is whether Germany actually does have 20% of the workforce in manufacturing. Indeed they have:
But you might also have noticed something else from the graph above, here is Brookings:
This trend can be observed in all of the advanced economies, including ones such as Germany that have large trade surpluses. Manufacturing's share of employment in Germany declined by 15.5 percentage points during 1973-2010, very similar to the U.S.'s 14.7 percentage point decline. If the U.S. were to run a trade surplus, as Germany does, there is likely to be a one-time gain in manufacturing employment, but then the trend decline will continue. In the event of a surplus, we would consume less of our GDP (and consumption is mostly services) and export more (U.S. exports are mostly manufactures). Hence, there would be a one-time shift of capital and labor from services to manufacturing. Then, the trend decline of manufacturing employment would continue as long as productivity growth in manufactures is faster than that in services.
Although starting from a higher level, it shows that German manufacturing employment is subject to the same eroding forces as US manufacturing. Since Germany, as a smaller economy is actually more open to trade compared to the US, it isn't so much trade, as simply automation that is mostly responsible for the decline in manufacturing employment, even in Germany.
That decline would likely have been even a bit worse in Germany if not for the fact that Germany has been benefiting from the euro for quite some time already, both within the eurozone, and beyond, as explained here.
We have already argued that we don't think the US government will get much mileage out of protectionism. It might make for a few nice headlines, but it's not a structural solution for getting a meaningful amount of manufacturing jobs back. After all, Germany isn't protectionist either.
The German economic model
What is underappreciated is the German economic model, which is responsible for its longstanding industrial success. It consists of a few institutional arrangements which are quite different from those in the US, and it would be difficult to copy these.
- The "Mittelstand"
- A vocational training system
While Germany does have numerous big international companies that operate on a global scale, the likes of Siemens, Bayer, BMW, Volkswagen and the like, the backbone of its economy is provided by highly specialist niche players of medium size, often family owned, the so called "Mittelstand."
These companies thrive for various reasons. They have deep local roots and therefore command often extreme loyalty from their employees. From The Economist:
"...on average only 2.7% of them leave each year, compared with the 30% turnover at some big American companies."
They are also niche players, world-class companies in a highly specialized market (often capital goods), which compels them to remain close to their core competencies and keep improving and innovating.
Can the US learn from Germany? It's always useful to look at how things are done elsewhere, especially when these are successful. But The Economist has a useful warning:
The first is that business models can never be transported lock, stock and barrel. The German system depends on delicate relationships between schools and companies, and capital and labour. It is hard to see this being reconstituted in South Korea, with its adversarial industrial relations, or the United States, with its enthusiasm for labour mobility. The British have been trying to learn from the German apprenticeship model since the late 19th century, with limited success.
We can see numerous institutional problems for efforts to create something similar in the US:
- US companies generally have less incentive to invest in worker skills because the higher level of labor mobility. Workers have less incentive to invest in acquiring company specific skills for the same reason. One of the distinguishing features of the Mittelstand is the low level of labor turnover, but this is hard to replicate in the US.
- Since most of these companies aren't listed on any stock exchange, they are often financed by more patient capital and face less pressures to deliver quarterly improvements, or spend cash on share buybacks or ambitious takeovers. Instead they can fund longer-term projects and projects with a more uncertain return. The companies are more often run by engineers with a focus on product excellence, rather than finance with a focus on stock returns.
- There isn't much of the German vocational training system in the US either. It's a dual system, with classrooms and on-the-job apprenticeship training. There are some 350 different courses, many of which are popular as the job prospects are generally good. Almost 60% of young people are in such programs, while the number for the US is just 5%.
- The Mitbestimmung, or codetermination gives labor a role in running the company on the level of the shop floor as well as in board representation. This doesn't sit well with US style capitalism so the chances of it getting emulated are fairly slim (even if there is a small sector of US firms which have significant employee participation, like Southwest). This isn't the place to discuss the pro's and cons, but it might be one way of mitigating some of the problems of shareholder capitalism.
- A more extensive welfare state (like universal healthcare) which, while expensive, allows labor to be more protected from market changes.
Protectionism isn't going to turn the US into Germany, at least not its most recent version. Recreating the institutions that underpin Germany's manufacturing success in the US is a tall order. Much of it is pretty alien to the US business culture with its more fleeting relations, dominance of finance and shareholder value, and lack of vocational training.
At first sight, it looks like the German model is much less exciting for investors. Many of its successful firms aren't even listed on any exchange. Even when listed, shareholder value and concerns are often given less priority compared to American firms.
This isn't necessarily a disadvantage for shareholders though as it can free companies from some of the quarterly figure pressure and focus more on the long term, like Amazon, or experiment with new corporate governance priorities like Southwest. Shareholders have done pretty well in these companies, see the chart of Southwest (NYSE:LUV) above.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.