Does Germany know the secret to creating jobs?

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Something pretty incredible is going on in Germany. While the U.S. and much of the rest of the developed world is suffering not only with high unemployment, but also stubborn unemployment, Germany has been heading in the exact opposite direction. Defying the odds, Germany’s unemployment rate has been declining during the Great Recession. According to the OECD, German unemployment stood at 8.6% in the boom year of 2007; in 2010, the OECD estimates unemployment fell to 6.9%.

What’s even more interesting is that Germany is creating jobs using the Obama administration’s preferred strategy for America – through exports. Germany is experienced a giant surge in exports (up 18.5% in 2010) and that is driving the economy. And those exports to a great degree are industrial goods churned out by German factories. Germany specializes in machinery and other heavy equipment – it’s not sexy stuff that grabs headlines, but it sure is good business. Factories and power plants in places like China and India need just this type of equipment to drive their own economic progress. So Germany has formed something of a complementary relationship with emerging economies. Simply put, Germany has found a way to create jobs through maintaining manufacturing competitiveness.

How has that happened? You can read about Germany’s economic revival and its impact on the world in my latest TIME magazine story, but here’s a bit more analysis on the jobs issue.

First, we have to give credit to the German government for a slate of reforms and programs that have really helped job creation. Germany (much like Spain) had a chronic unemployment problem, a result of a labor market that was too highly regulated and offered too much protection for workers. German policymakers began to change the system back in 2003 with a series of measures that made the labor market more flexible and encouraged greater participation in the workforce. Then during the Great Recession, the government and corporations devised all sorts of schemes to prevent the kind of mass layoffs that plagued the U.S. Most interesting was a government-funded short-time work program. Companies put workers on reduced working hours rather than laying them off; the government stepped in with subsidies that paid part of the workers’ salaries.

But there is something much more fundamental going on as well. German industry is committed to making the sort of high-quality, high-performance, innovative products for which the world will pay extra. In other words, Germany is making BMWs, not Chevys. If you’re making a BMW and charging so much for it, you can manufacture in a high-cost environment and still make a nifty profit. If you’re making a Chevy, which to a greater degree competes on price and doesn’t have a strong brand reputation, you can’t charge the premium that makes profitable manufacture in the U.S. as easy to accomplish. Germany manufacturers are extremely focused on quality, engineering and research & development, and that shows in the products they make, and the prices they can charge. They make stuff that can’t so easily be reproduced elsewhere. So even though Germany is being challenged by Chinese industry, German companies have managed to stay a step ahead as well. In other words, it all gets back to innovation, in whatever industry you happen to be in.

Even that’s not the whole story, however. There is something much harder to define behind Germany’s jobs miracle. That has to do with the commitment of executives to keeping jobs in Germany. Sure, German companies have opened factories in China and outsourced to Eastern Europe. Yet many German firms are stubbornly maintaining a certain amount of production within Germany as well. Part of the reason is skills. Germany has a lot of very talented engineers and assembly-line workers who are crucial to making those high-quality products that sell for so much money. But I’m going to speculate that part of the reason can be found in Germany’s corporate structure. The backbone of German manufacturing is small to mid-sized firms that are often family-owned. These families are in many cases committed to keeping factories at home. Though they want, of course, to make as much money as possible, they’re not under the same pressure from shareholders to show bigger and bigger profits each quarter. That allows them to take a long-term view. German management also just seems more determined to find ways of staying profitable while still manufacturing in Germany. The chairman of power-tool maker Stihl, Bertram Kandziora, told me that U.S. companies “don’t try hard enough to keep production inside the country.”. That’s especially true, he pointed out, since labor costs in Germany are actually higher than in the U.S.

Of course, the German system is far from perfect. Unions have chosen to accept small wage increases in recent years to preserve employment, but that means the income of the average worker hasn’t benefited as much from Germany’s economic revival as you’d think. Many workers find themselves in unstable, poorly paid jobs. And you also have to question is the German jobs story is sustainable. There is a looming shortage of skilled workers in Germany, as industry expands but the population ages. Demand for talent will eventually push wages up and make manufacturing in Germany less competitive. But what Germany does show is that a high-cost economy can compete and create jobs in manufacturing with a rising China using the right mix of commitment, innovation and national policy.