What’s wrong with German Innovation?
A look at where Germany R&D spending goes wrong
My University English teacher once asked our class what stereotypes we hold for different countries. While this was a great exercise to showcase the ignorance of us young students in a non-accusatory way, something else stuck with me. When he asked us what stereotypes others might hold of Germans, we came up with the average Oktoberfest visitor: beer (belly), Lederhosen, and Schnitzel-enjoyer. When he told us that there was also the idol of the German Scientist-Entrepreneur, we didn’t believe him at first. How could others think so highly of Germans when „Made in Germany“ lost all its prestige at home?1
German engineering used to be extraordinary. That much is obvious just by looking at the DAX: Siemens, Bosch, Mercedes-Benz, Porsche. All of them were founded by engineering-entrepreneurs, translating novel research into products and successful companies. To this day, a large part of Germany’s economic success relies on the same legacy companies to keep up the entrepreneurial spirit of their founders. And they do to some extent: almost 70% of Germany’s R&D spending stems from industry - a common ratio of public to private R&D investments, as it matches the US (72% in 2019)2, South Korea (76% in 2022)3 and Japan (73% in 2020)4.
Nonetheless, Germany’s performance in the innovation race is dismal: Of all patent grants by origin country and technology field, China dominates 29 fields while the US and Japan lead in four and three respectively (see figure 15). South Korea also holds 10% of global patents granted and can hold its own in the semiconductor, automotive, shipbuilding, and consumer electronics industries. Germany can’t boast leadership in any innovative technology. Its share of global patents has declined from around 17% in the early 1990s to around 6% by 2021, while its share of the most cited scientific publications halved over the same period. While the US is far ahead in total spending, Germany is between South Korea and Japan. So, neither the total budget nor the predominantly private research spending are problematic. It comes down to the effectiveness and risk-taking in spending on R&D.
In 2021, Wim Naudé and Paula Nagler6 recognized the decline in German innovation and identified several factors. I want to highlight two: a) The lack of radical or breakthrough innovations and the predominance of incremental innovations, and b) the stagnation in entrepreneurship.
The focus on incremental improvements on existing products hampers dominating a technological sector over a long period. This is shown in Germany’s trademark and best-performing industry: building cars. The old-line companies invested over a third of Germany’s private R&D spending7. But what they have to show for today is high-quality cars with combustion engines or over-expensive luxury EVs. The next generation of high-quality middle-class EVs in Europe arrives at Hamburg harbor from China, not off the assembly line in Wolfsburg. Noah Smith highlighted in his blog post that next to hefty government subsidies, it was the innovation in EVs that allowed BYD, SAIC, and Tesla to challenge German car makers. Their lack of ability to produce cheap EVs is also a reason that the planned EU ban on cars with combustion engines by 2035 might be dismissed after the European elections this summer.
As Germany fights to jump-start its economy after four years of virtually no growth, The Economist slanders again about the Sick Man of Europe. With the small pride German media can muster for their homeland, they tried to analyze the remaining strengths of the country. For example, the national pendant to The Economist, the business paper Handelsblatt, evaluated eleven high-performing industries and claims to have demonstrated a remaining attractiveness of Germany as an industrial site. What they impressively showed instead is that all former high-tech and innovation industries in Germany shrivel: vehicles, pharma, electrical equipment, precision manufacturing, and chemicals all continually lose ground in terms of global share in exports, patents, and domestic value creation.
This wouldn’t be too bad if the old guard of companies would eventually be replaced by new startups. But Germany just doesn’t produce any tech champions. The last successful tech company was SAP - hardly anywhere near the weight class of Apple, Nvidia, or Microsoft. In almost all new technologies, the US wins the race to have the first commercial product simply by funding their promising tech startups properly. Seven of the eight best-funded AI startups are based in the US, and the eighth sits in France and is funded by one of America’s largest VC funds8. Of all globally active companies pursuing a commercial nuclear fusion power plant, half are based in the US, with more than two-thirds of all private investments. At the same time, German startups attracted a meager two percent.
Germany is losing out on the innovation race: the federal government needs to increase spending on potentially breakthrough basic research and education to build a solid foundation, even if that means taking the risk of funding research that will lead nowhere. The Universities and research institutes also need to stop culling their potential spinouts to “protect“ intellectual property and start to actively nurture the ideas planted within their organizations, as UnternehmerTUM already does laudably in Munich.
German VCs, and especially the German legacy heirs, need to update their risk profiles and invest heavily in the next generation of deep-tech startups. Otherwise, the diagnosed disease will become chronic.
That was the case in 2016. Today, the German self-awareness ranges from being the „Sick man of Europe“ again to a Chancellor who seems to be blissfully unaware of any real economic issue within the country.
In 2019 private R&D spending accounted for 72% of the total according to the National Science Foundation: https://ncses.nsf.gov/pubs/nsb20225
https://www.investkorea.org/ik-en/bbs/i-465/detail.do?ntt_sn=491700
https://www.stat.go.jp/english/data/kagaku/1547.html
https://static.wixstatic.com/media/1df6ca_90c068bddc3a47d5bcc8c15a2f342e6f~mv2.png/v1/fill/w_740,h_740,al_c,q_90,usm_0.66_1.00_0.01,enc_auto/1df6ca_90c068bddc3a47d5bcc8c15a2f342e6f~mv2.png
https://docs.iza.org/dp14154.pdf
https://www.kfw.de/PDF/Download-Center/Konzernthemen/Research/PDF-Dokumente-Fokus-Volkswirtschaft/Fokus-2022/Fokus-Nr.-404-Oktober-2022-FuE-Entwicklung.pdf, Document in German, page 5
https://www.statista.com/chart/32063/top-8-ai-startups-worldwide-according-to-capital-invested/