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Special Report: Rebooting Germany - Where Europe's most powerful economy is falling behind

[June 25, 2018] By Paul Carrel

MASSEN-NIEDERLAUSITZ, Germany (Reuters) - Until March of this year, goods arriving at family engineering firm Zemmler Siebanlagen in eastern Germany generated piles of paperwork and hours of manual cross checks. These days, stockman Ronny Mucha records deliveries on a specially designed tablet application that immediately updates other departments. It takes a fraction of the time.

The firm's founder, Heiko Zemmler, credits a government-backed scheme with "taking us through a psychological barrier" about digital technology. The inventory application is just a beginning, hopes Zemmler. One day he wants his welders and assembly line workers to be able to access design plans and lists of parts on a shared platform.

That's all common enough in modern factories from California to South Korea. But there's a problem. Zemmler needs high-speed internet capable of carrying large quantities of data to make the switch. "Broadband has come to many people, but unfortunately not to us," he said at his plant in the Brandenburg region, not far from the Polish border.

Europe's most powerful economy, at the forefront of industrial innovation for decades, is struggling to adapt to the digital age, and its policymakers are worried.

Zemmler's experience encapsulates two key obstacles to change here. It took a nudge by the government to get him to embrace digital technology in the first place. And, now that he has done so, his plans are being frustrated by a woeful broadband network.

A 2017 study by the Organisation for Economic Cooperation and Development (OECD) ranked Germany 29th out of 34 industrialized economies for fast internet connections. Japan and South Korea lead the pack. Chancellor Angela Merkel has made fixing Germany's digital deficiencies a priority for her fourth and likely final term, saying "our future prosperity depends on it."

In interviews, company bosses and senior policymakers set out the scale of the challenge the government faces and explained why German firms have been slow to adopt digital technology to store and share data and manage workflow.

The paucity of high-speed internet was one barrier, they said. Others included government inefficiency and a reluctance among small and mid-size firms, Germany's "Mittelstand," to embrace new ways of working. Added to that, years of surveillance by the Nazis and then the Communists have left many Germans suspicious of data sharing.

There's also a paradox at work: Germany's strong economy is blocking efforts to modernize, they said, with firms too busy meeting orders today to plan for a digital future.

Government data shows the extent of the problem. A government fund created to expand Germany's broadband network managed to spend only three percent of the money available last year, figures in a Jan. 23 letter from the deputy finance minister at the time, Jens Spahn, to a fellow lawmaker showed. Spahn has since said Germany is up to 20 years behind U.S. competitors, with many managers stuck in the "fax age."

Even Germany's car industry is feeling the threat. In the past, Chinese firms sought to learn from German carmakers. But on a trip to China in May, Merkel was so struck by China's progress in data processing that she asked for Chinese help to develop electric and autonomous vehicles. China has yet to commit.

To be sure, Germany has shown an enviable ability to adapt to political, economic and technological challenges over the decades. At the turn of the century, it was called "the sick man of Europe," with an inflexible labor market that weighed on productivity. Chancellor Gerhard Schroeder's government responded by shaking up the welfare system to encourage more people into the workforce. It turned out well: Germany regained competitiveness and profited from demand in the industrializing world for its high-end engineering products. Unemployment has fallen from above five million in 2005 to less than half that level now.

"Germany has overcome much bigger problems before," said Carsten Nickel, managing director at consultancy Teneo Intelligence.

"But it did so by not shying away from, at times, radical change. That, in turn, requires agency and political leadership. Schroeder ultimately lost his job over his economic reforms. It would probably be a stretch to claim that a comparable willingness for bold political leadership exists in Merkel's Berlin today."

Indeed, Merkel has spent much of her political capital this year trying to defuse a row in her coalition over immigration policy.

For graphic on jobs at risk from new technologies, click https://tmsnrt.rs/2K8cTYT

MONEY TO SPEND

Alexandra Horn's team at the BVMW Mittelstand association of small and mid-size firms worked with Zemmler to introduce the inventory application his company now uses. It is part of a government-backed scheme called "Digital Together."

Horn says she has sometimes been met with laughter when taking this digitalization drive to firms outside the main cities like Berlin, where a healthy startup scene masks slow progress elsewhere. Because of poor internet speeds, "digital business models cannot be implemented, plain and simple," Horn said.

According to the OECD, just 16 percent of German firms use cloud services, "a key productivity enhancer." That's well below the OECD average of 25 percent and far behind countries including Finland (57 percent), Sweden (48 percent) and Japan (45 percent).

"If you don't have the infrastructure, you cannot have a successful digitalization of the economy," said OECD telecoms and internet expert Verena Weber.

Germany's coalition government has pledged to provide high-speed gigabit internet access across Germany by 2025. It aims to develop a fiber optic network to all corners of the country. Japan has 76 percent of its broadband via fiber, Latvia 62 percent and Sweden 58 percent, compared to just two percent in Germany, OECD data show.

For a graphic on German broadband, click https://tmsnrt.rs/2Kms53N

Efforts to upgrade Germany's internet with state-of-the art fiber technology are coming late partly because Germany's telecoms industry regulator, BNetzA, allowed Deutsche Telekom, the former national network monopoly, to use an intermediate solution called "vectoring technology" to increase the bandwidth of existing copper lines instead of running fiber all the way into homes and offices.

For a graphic on the rise of fiber, click https://tmsnrt.rs/2K6IPwK

Finance Minister Olaf Scholz said in May the government would use higher-than-expected tax revenues to start a digitalization fund into which his ministry would transfer 2.4 billion euros ($2.85 billion) this year. The fund will be increased by revenues generated from the auction of 5G mobile licenses.

But throwing money at the problem is not guaranteed to fix it, as shown by the Jan. 23 letter from Spahn, the deputy finance minister at the time. It revealed that of the 689 million euros set aside by the government for broadband investment, only 22 million was used last year. Policymakers and company bosses complain that tender operations for subsidies can be so slow and complex that federal funds often go unused. Chancellor Merkel agreed.

"We must speed up approval procedures" for investment, she said in May.

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Managing director Heiko Zemmler poses for a portrait at his machine-building company Zemmler Siebanlagen in Massen, Germany, March 22, 2018. REUTERS/Hannibal Hanschke

For Kyffhaeuserkreis, a rural district in the eastern state of Thuringia, moves to streamline the process can't come soon enough. Kyffhaeuserkreis is still waiting for its high-speed broadband three years after setting the wheels in motion. The tender process alone has taken almost two years.

"Meeting the requirements of the funding guidelines was not easy," said district authority spokesman Heinz-Ulrich Thiele.

Another problem is that no single government department is in overall charge. The ministry for transport and digital infrastructure is in charge of broadband rollout, the economy ministry for promoting new technologies, the interior ministry for security and the justice ministry for consumer protection in the digital age. In addition, regional authorities grant planning permission.

In an attempt to address these issues, Merkel appointed Bavarian politician Dorothee Baer as her Minister of State for Digital Affairs in March. In an interview with Reuters, Baer conceded that "we still need a bit more effort" but she believed the government had done its job. "The money is lined up, transferred - and now the rollout simply needs to happen."

There is broad agreement that the broadband infrastructure needs to be fixed and digital technologies promoted. The cabinet has approved plans to use federal money to promote digital education in schools. But, a senior government official said, the funds will not be released before November because the policy requires a constitutional amendment. That is because education is traditionally the preserve of Germany's 16 states - another example of bureaucracy slowing the digitalization drive.

JAM TODAY

Heiko Zemmler honed his engineering skills repairing mopeds in former East Germany. He began leasing and servicing industrial sieves for the construction, forestry and waste management industries in 2000 and later began manufacturing them, establishing Zemmler Siebanlagen GmbH in 2010. With recent annual sales growth rates of 20 percent to 30 percent, Zemmler said he was so busy fulfilling orders he didn't consider shifting to digital technology until the BVMW Mittelstand association contacted him.

It's a familiar story. The transition to digital technology is being overlooked because of roaring growth now. Last year, the German economy grew by 2.5 percent, the strongest pace since 2011, outperforming France and Italy.

Digitalization czar Baer said firms need to think ahead.

"Of course, it's pleasing that the order books are full now, but that will not automatically remain the case," she said. "The German Mittelstand is characterized by the fact that it thinks long term, in generations instead of in quarters. Without digitalization, no company can be future-proofed."

Germany's construction sector too is experiencing a boom, with forecast sales growth of six percent this year. Building firms can cherry pick the contracts they want to take on, and broadband contracts are not top of the list. Again, Germany's success now is acting as a brake on progress.

Deutsche Glasfaser is a privately funded company that builds fiber broadband networks. Its managing director, Stephan Zimmermann, said fiber broadband rollout requires such specific training and machinery that many German construction firms shun it to work on more traditional projects on which they already make good money.

Zimmermann is looking abroad for construction firms to help with projects.

"I am now looking across Europe to attract Spanish, Greek, Dutch companies to invest in Germany. That is working out for us ... though it is a lot of work to make it happen," he said.

SUSPICIOUS MINDS

Fixing the high-speed internet issue is one problem, changing mindsets quite another.

Extensive surveillance, first by the Nazis and then by Communist East Germany's Stasi secret police, has led to Germans closely guarding their privacy and personal data. Merkel says it is time to move forward. The development of artificial intelligence is underpinned by data sharing, she reasons.

"To think that we can be at the forefront of artificial intelligence and be as restrictive as possible with data is just like wanting to rear cows without feeding them," she said in May.

Digital czar Baer complained that "there is always a great deal of foggy angst" about digital technology.

Aerospace engineering graduate Daniel Wiegand said he experienced this mindset first-hand in the early days of his business. Wiegand's firm, Lilium, is one of a handful of companies that are developing electric vertical take-off and landing vehicles, "flying taxis." Others include California-based Karem Aircraft, Brazil's Embraer and Pipistrel of Slovenia.

Wiegand recalled the scepticism he encountered when setting up the firm with two friends in Germany in 2014. Seeking a fourth partner with expertise in flight control software, Wiegand interviewed PhD students at his alma mater, Munich Technical University.

"I think after one or two minutes, 50 percent of the people left the room and said, 'This guy is crazy'," he recalls. Such reticence is widespread. Germany saw a two percent drop in the number of small businesses founded in 2017 after a 10 percent drop the previous year, Statistics Office figures show.

Wiegand persevered. The upshot: an award-winning start-up with tens of millions of dollars of venture capital funding. The company has developed a heavily digitalized, vertical take-off jet, and plans to offer on-demand flying taxis before 2025.

Germany needs to become friendlier to entrepreneurs, he says, echoing a recommendation of economists at the OECD.

"It's about the people and the culture that brings about these ideas," said Wiegand. "In California, they have a totally different culture and experience over almost two generations now - and that's what makes the difference."

If Germany can get its digitalization drive right, it could spur fresh economic development just as its longest period of uninterrupted growth since reunification is starting to wane. An OECD report presented on June 12 concluded that if, through investment in broadband, Germany's average connection speed catches up with the average of the top 10 countries by 2025, GDP per capita will get a three percent boost after 10 years.

($1 = 0.8420 euros)

(additional reporting by Andreas Rinke in Berlin and Douglas Busvine in Frankfurt; editing by Janet McBride)

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