Trade Trends: Germany’s China opportunity

   The United Kingdom’s historic and shocking decision to exit the European Union has provided the fuel to power countless op-eds. 
   As the European Union’s largest economy, Germany is a key part of that story. But the “Brexit,” which I examined in depth in last month’s Trade Trends column, is not the most impactful economic change affecting Germany’s long-term prospects. For that, look to what China’s transformation truly means for both businesses and consumers in Germany. 
   First, a sober take on Brexit. Of course it introduces a new trade barrier between Germany and the United Kingdom, assuming an exit actually occurs. But I’m skeptical that it will have a material impact on Germany.
   All other EU vendors looking to export to the United Kingdom will have the same proportional disadvantage, so the most likely outcome is that British importers will maintain existing trade relationships and simply pass the extra costs of imports on to the consumer as the price of their country’s withdrawal. Contrast this with Germany, which can cut British exporters out of the equation, and instead source its import needs from a number of other EU countries.
   Compared to the sudden Brexit news, China’s evolution has been a slow and steady crawl, but it is the real focal point when examining Germany’s future. China is progressing through a multi-decade plan of economic transformation, going from an export-driven economy to a consumption-oriented one, and this has major ramifications for Germany.

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   China does not want to be the world’s assembly line any longer. A substantial part of its long-term strategy is to trade in finished goods instead of components and raw materials that require assembly and then export, and this shift favors countries that have a reciprocal focus on complex finished goods, sophisticated technology, and manufacturing efficiency. Germany meets these requirements and seems well-positioned to satisfy China’s evolving type of demand. For example, in 2014 it exported more than twice as many automobiles as vehicle parts and more than three-times as many planes as aircraft parts. 
   This is why HSBC forecasts that China, which is a top-four trading partner of Germany today, will be the top import and export partner for German businesses by 2030.
   Germany’s China opportunity highlights just how unique Germany’s export sector is. Germany has thousands of midsized, highly specialized companies that are each true global leaders in their product niche. Many of them are family-owned, which accommodates long investment horizons, conservative management principles, and low risk, ultimately giving them strong capital buffers and a greater likelihood of long-term profitability. 
   The operating principles that this ownership structure permits helps prevent these companies from becoming chips in risky consolidation table games, which explains why they occupy so much space in mature segments across Germany’s manufacturing sector. Many of these companies also have a global perspective in their very DNA—they had to become export-first international enterprises early since the voids they fill are highly specialized and narrow. 
   It is difficult to find examples of U.S. companies in the $50 million to $200 million range that export three-fourths of what they make, but this is common for these German “Mittelstand” firms. They allow Germany’s export machine to perform far above the other top EU economies. 
   Strong labor has historically been a big part of this story. In 2014 research published by the International Trade Union Confederation’s Global Rights Index, Germany has the highest labor rights score possible, and it is currently in the top 10 in GDP per hour worked, according to Organization for Economic Cooperation and Development (OCED) statistics.
   The high value-added component of German manufacturing and the strong ties manufacturers have to their communities have kept Germany’s manufacturing local despite the presence of low-cost locations with less organized labor across Eastern Europe. There is some evidence, however, that the backbone of Germany’s manufacturing sector—its workers—may be entering the workforce less prepared. A recent OECD study noted that Germany lags behind Canada, Australia, the United Kingdom, and Denmark in recruiting overseas experts. And the recent ugly backlash regarding Europe’s refugee crisis doesn’t help. 
   If these labor difficulties end up being a blip instead of the beginning of a trend, Germany’s economy will continue to be a safe bet for the future and offer methodical, predictable growth. But for those who are not excited by mere stability, there is potential for significant upside. 
   China’s economy is slow now, but designed to demand more finished goods and complex manufacturing eventually, and the rest of Asia is becoming more technologically advanced. If Germany’s stable manufacturing base can weather the storm brought on by this temporary slowdown in China and continue to climb higher up in the value-added stack, it could end up as Asia’s premier provider of high-value goods that are difficult to commoditize.