Report

Nov 09, 2021

Technology and Industrial Policy in an Age of Systemic Competition

Safeguarding Germany’s Technology Stack and Innovation Industrial Strength
Visual Industrial Policy
Key Takeaways

As one of the world’s most globalized economies, Germany is confronting a challenging international environment characterized by aggressive subsidies, a global race for control of key technologies such as advanced chips, and vulnerable supply chains for critical components. Increased energy costs – induced by Russia’s war on Ukraine – are also straining Germany’s industrial model.

Germany’s industrial economy is simultaneously undergoing a fundamental transformation from precision-based engineering to systems-based manufactured products. With this shift, a competitive digital technology stack is becoming a key repository for future industrial competitiveness. Yet, the country struggles to capture value in fast-growing markets like that for cloud and edge infrastructure. It also faces risks from its exposure to untrustworthy technology vendors and potential geopolitical disruptions to fragile hardware supply chains.

The German government is consequently drawing the contours of a new technology-industrial policy. This effort, however, suffers from uneven implementation and the complexities of effectively coordinating subnational (across the länder) and supranational (across the EU) industrial policy.

To effectively preserve its economic competitiveness, the German government should conduct a systematic assessment of the country’s strengths and vulnerabilities in critical technology, increase the cohesiveness between federal and state government initiatives, and work internationally – within the EU and with like-minded partners beyond – to leverage comparative advantages.

 

Introduction

Berlin’s stance on industrial policy is evolving significantly. Specifically, its digital policy, long focused on data rules, competition, and open markets, is now confronting a new global environment characterized by aggressive subsidies, a global race for market share in key technologies such as advanced chips, and vulnerable supplies of critical components. China has become a direct competitor as it moves up the value chain following a transition from labor-intensive manufacturing to advanced production in autonomous and electric vehicles, smart machinery, robotics, and network equipment sectors. The United States, for its part, is investing heavily in its innovation industrial base to defend its technological primacy in domains such as cutting-edge chip design and AI.

These challenges have forced Germany to undertake a more active industrial policy. At stake is the country’s future economic prosperity, as its technology-industrial base grapples with a shift from precision-based engineering to systems-based manufactured products reliant on data and algorithms, digital infrastructure, and semiconductor supply chains. Unless the country can skillfully use technology-industrial policy to safeguard its strong position in global high-tech value chains, its economic base and geopolitical influence will diminish. To avoid this, the German government must reconcile such a policy with the open-market and choice-based principles underpinning its domestic economy as well as the geopolitical imperatives for fostering strategic interdependencies with close allies and partners.

The State of Play

Germany’s industrial transformation is forcing the country to bring together its excellence in the automotive, machinery, medical engineering, and other sectors with technologies, such as AI and emerging digital ecosystems. This has created acute ­challenges to its industrial competitiveness, in part because the country’s mid-sized businesses – its famous ­Mittelstand “hidden champions” – display relatively low levels of new technology adoption. For instance, a mere 6 percent of them have implemented AI strategies aimed at retaining competitiveness. A large majority (77.1 percent) say, too, that they are ambivalent about the benefits of data sharing despite its importance for securing a competitive edge by optimizing industrial processes and developing new products. Moreover, the country’s landscape of industrial Internet of Things (IoT) and data-sharing platforms is fragmented. Initiatives for European data spaces such as Gaia-X advance slowly, reflecting internal quarrels over the participation of non-European players and the political challenge of advancing a common European ecosystem based on interoperability and trust.

Germany, however, has advantages in its existing innovation industrial base. The country embraces networking and automation as the world’s fourth-largest spender on IoT, which comprises internet-connected devices such as sensors and meters, and it accounts for a third of Europe’s operational industrial robots. Domestic AI development also meets half of German industrial demand. According to estimate, KI-based solutions could provide a major economic boost by increasing German GDP by 11.3 percent, or €430 billion, through 2030. But policies to accelerate the translation of Germany’s R&D strengths into data-intensive and systems-centric applications in its domestic industrial base are key to securing the country’s position as a top-tier technology ­power.

With this shift to data-driven value creation, a competitive digital technology stack is becoming a key repository for future industrial competitiveness. A fundamental concern in this regard, however, is the availability of secure and reliable cloud and edge computing infrastructure. This is not just because Germany’s continued leadership in core industries, such as autonomous driving, manufacturing, and energy grid management, increasingly depends on cloud-based big data processing. It is also because decentralized cloud infrastructure, in particular, will underpin Germany’s rapidly growing industrial IoT and the requirements for highly secure and low-latency computing carried out close to the data source, the so-called “edge.” Germany is forecasted to remain Europe’s largest and fastest growing market for edge computing through 2025, when the majority of business data will be processed outside traditional, centralized data centers.

And yet, Germany, like all of Europe, struggles to capture value in the fast-growing market for cloud and edge technology. German cloud providers such as T-Systems and SAP are turning to operational partnerships with US hyperscalers to reconcile advanced cloud technology with data protection requirements, especially with regard to limiting the legal grounds and technical possibilities for foreign access to data stored on European servers. Meanwhile, the shift to edge computing is also altering the sources of comparative advantage. Unlike more general-purpose cloud infrastructure, edge computing is characterized by wide geographic distribution of data centers and tends to be adapted to specific verticals and applications. This could impact competition between large cloud providers and incumbent telecommunication companies.

Germany’s conflicted strategy for secure telecommunications networks, which increasingly fuse with the cloud-based data-processing infrastructure, presents another challenge. Chinese vendors currently play a significant role in German telecommunications networks, with Huawei alone providing almost half of their 4G base stations. Germany is attempting to limit exposure to Chinese firms in 5G networks but is not ready to shift to European providers. German telecommunications operators, after all, have a strong commercial interest in diversifying their network providers and limit reliance on European companies Nokia and Ericsson, the second- and third-largest 5G base station vendors. Accordingly, Berlin has supported the O-RAN Alliance, a major industry and research initiative aimed at defining interoperable standards for mobile networks. The support comes despite questions about the security of O-RAN’s architecture and discord with key partners, including France and the European Commission, over O-RAN’s ramifications for Europe’s 5G champions

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Germany also faces risks in the fragile supply chain for semiconductors, the foundational technology that powers industrial IoT, smart grids, electric and autonomous vehicles, and other industrial components and products. Europe’s share of global semiconductor manufacturing capacity has fallen from 44 percent in 1990 to just 8 percent today. In 2020, Infineon was the only German company (and one of only four European companies) among the 20 largest semiconductor ­manufacturers in terms of revenue. More than three quarters of chip production now occurs in Asia, primarily in Taiwan, South Korea, and China. Disruptions in this ­geopolitically precarious region would have a profound economic impact on Germany, one likely much greater than that of severed Russian gas supplies.

Germany and its EU partners need a strategic and measured approach to industrial policy in this highly complex and diversified market. Given high capital barriers to entry, re-shoring (cutting-edge) manufacturing requires substantial and sustained subsidies. This means diversifying global sourcing options should be a priority, as is identifying comparative advantages in the semiconductor value chain. Crucially, Germany still boasts legacy strengths in certain supplier markets and production segments. Precision-engineered components and specialized chemical products from German companies such as Zeiss and BASF are critical ingredients for semiconductor production. And Infineon, Bosch, STMicroelectronics, and NXP excel in specialized chips, including those for industrial applications, automotive, and defense.

Yet, Germany must not lose sight of future disruptions. An increasing number of (industrial) companies design their own specialized chips while intellectual property holders and Electronic Design Automation (EDA) tool vendors are almost exclusively located in the United States. Developments in quantum and high-performance computing give Germany an opportunity to secure a stronger position in the hardware segment in the future. But German companies, despite strengths in basic research, lack competitive hardware products, a sector that changes increasingly rapidly.

The Current Policy Approach

The German government is aware of all these shifts and is drawing the contours of a new industrial policy. In a range of high-level documents, most notably its “High-Tech Strategy 2025” (released in 2018) and “Industrial Strategy 2030” (released in 2019), ­Berlin adopted a more strategic outlook on critical technologies that dovetails with the bigger €750 billion NextGenerationEU plan. German policy remains anchored in its long-standing ordoliberal principles of open markets and freedom of choice, but it now acknowledges a greater role for state intervention to preserve industrial value creation. Pandemic-related economic disruption solidified this outlook, leading Germany to frame its €130 billion recovery stimulus package as a “package for the future” that prioritizes digital investment for economic recovery.

Germany has promised significant public investment in critical technology. The country’s first-­ever AI strategy, released in 2018, featured a €3 billion investment, later increased to €5 billion, through 2025 to support talent development, computing facilities, and internationally competitive AI ecosystems. The federal government also committed in 2019 €650 million to strengthen Germany’s quantum physics research. That funding was increased in 2021 to €2 billion, with the explicit goal of obtaining a competitive “Made in Germany” quantum ­computer by 2025.

And yet, this transition to a more state-led technology-industrial policy still faces challenges. ­Germany may outspend other EU member states in this domain, but it struggles with uneven implementation. While the country has, for example, achieved its goal of hiring 100 AI professors, it has, as of mid-2021, only disbursed €250 million of its €5 billion AI investment package. Besides bureaucratic holdups, this reflects the government’s lack of a coherent process for following through on strategic priorities.

In addition, Germany’s federated structure complicates synergies between federal and state (länder) policy. German federalism can create healthy competition among länder that highlights different strengths and that experiments with policies to attract international investment and talent for cutting-edge technology. But to realize the desired “leveraging effect” between federal and länder initiatives, such competition must be embedded in a coordinated approach that assesses potential synergies. A potentially significant advantage exists in the interlocking of federal funding priorities and länder investment policies that have launched regional initiatives. These efforts include Bavaria’s €300 million financing for its Munich Quantum Valley to promote quantum sciences and technologies, and an initial €160 million package for Baden-Wuerttemberg’s Cyber Valley, currently Europe’s largest AI research consortium.

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Coordination at the supranational level likewise remains an important challenge to effective implementation. EU institutions have clout in defining the digital rulebook, but the member states drive industrial policy. Germany has a played a key role in overcoming this division of labor and advancing more coherent policymaking. This includes, notably, a commitment to several Important Projects of Common European Interest (IPCEIs), including those for microelectronics, cloud infrastructure, and ­batteries. But the IPCEI for cloud infrastructure and services (IPCEI-CIS), with €750 million of German funding, is entangled in disputes about the ­French-­German GAIA-X initiative, which allows American and ­Chinese hyperscalers to participate in establishing standards for Europe’s federated data infrastructure. Moreover, the IPCEIs for microelectronics face slow German and European Commission bureaucracy, and questions remain about these projects’ alignment with the €17 billion Intel fab project in ­Magdeburg, to which German public subsidies are slated to contribute approximately €6.8 billion.

On top of these policy inconsistencies, Germany’s other fiscal and geopolitical priorities compete for federal funding. The current German government faces intense pressure to promote fiscal consolidation starting in 2023 even as the recent Zeitenwende envisions a €100 billion special fund (Sondervermögen) for modernizing Germany’s armed forces in the face of rising geopolitical conflict. Russia’s invasion of Ukraine has also put inflationary pressures on energy and food, which is simultaneously accelerating and frustrating Germany’s climate transformation goals. There is a growing sense that technology industrial policy could become less of a priority.

Recommendations

Germany must use its industrial policy tools effectively to develop and secure access to critical technologies and preserve its economic competitiveness. To that end, it should:

Undertake a comprehensive mapping of goals and capacities in critical technology: Mirroring partners’ efforts, the German government should kick-start an interagency effort to map out three industrial policy ambitions: technological leadership, peer status with competitors, and necessity to mitigate dependency risks. These assessments should match strategic economic and security priorities with domestic and partner capabilities.

Increase strategic industrial policy cohesiveness between federal and state governments as well as among the länder: Germany should prioritize ensuring that states’ industrial policies align with national technology objectives. The Federal Ministry for Education and Research (BMBF) should establish a dashboard of state-level industrial initiatives that highlights unmet potential for asymmetric R&D and industrial alliances. Senior state officials, research consortia, and industry could use this tool to identify and realize synergies among initiatives in individual research fields and across industries, for example between hardware- (e.g., quantum computing) and software-related (e.g., natural language processing) R&D efforts.

Expand transnational industrial consortia in ­Europe and among like-minded states: The EU has a technological choice: hang together or hang separately. As the EU’s largest economy, Germany has significant agency to advance a strategic and coherent European technology-industrial policy. It should foster cross-border innovation industry consortia by advocating a streamlined IPCEI notification ­process, ­ensuring adequate staffing for caseloads, and ­dedicating funds that match its high-tech ambitions. Where like-minded states provide key value chain components, Germany should encourage the European Commission to create an IPCEI scheme involving foreign suppliers to amplify positive spillover effects.

Focus on domestic – and European – competitive advantages and strategic interdependencies within a larger community of like-minded partners: Global supply chains are too complex to reshore complete technology stacks. Germany should design its industrial policy to promote a larger community of like-minded partners that has the EU at its core but includes key partners such as the United States, Japan, and South Korea. This community should have three goals: IT security, supply chain resilience, and industrial competitiveness. Within these areas, industrial policy aimed at boosting competitiveness should link directly to German comparative advantages such as edge computing and industrial domain expertise (e.g., in the automotive, medical, and ­energy grid sectors) for specialized chips.

Structure public procurement to mitigate security and supply chain vulnerabilities: Germany’s largest purchaser of IT systems is its federal government, which can leverage its purchasing power to reduce strategic vulnerabilities, particularly in security-critical layers of its technology stack. Procurement requirements should support the scaling of a secure European cloud infrastructure for public services. Reforms should eliminate disadvantages for open-source solutions by making security, openness, and interoperability key criteria. Reforms should also facilitate the entry of (smaller) European competitors through a simplified tendering process and more transparent approval timelines.

 


About the Project

This DGAP project proposes an integrated policy approach to German digital capacities and ­objectives. Such a strategy should link Germany’s incumbent industrial strengths and digital ­governance objectives with its geopolitical aims. 

This is the third in a series of reports that outlines an integrated approach based on seven inter­dependent layers of a “technology policy stack”. For this analysis, the DGAP invited 30 individuals to join a working group and participate, between July and October 2021, in seven off-the-record workshops on the crucial strategic dimensions of Germany’s international digital identity. Participants included elected officials, candidates, and senior German government representatives; German political party staff responsible for platforms and coalition agreements; subject matter experts in technology and foreign policy; thought leaders and senior technology-company management; key academics, economists, and political theorists; and representatives of civil society and digital rights advocacy organizations. Additional experts were invited to take part in the workshops on an ad hoc basis. Each workshop focused on a layer in Germany’s technology policy stack. Working group members were ­consulted intermittently during the drafting of this series.

We are grateful to the Open Society Initiative for Europe for their generous support, which made this project possible. 

Bibliographic data

This is the third chapter of the DGAP Report "A Digital Grand Strategy for Germany". Download the full report here.