The German Economic Council calls its car industry “the lifeblood of the German economy.” Even in these volatile markets, Porsche recently completed a landmark IPO and went public at the highest market capitalization of any European public offering ever. German cars can be found in every corner of the world, and it is no coincidence that the catchphrase “German engineering” was popularized by an Audi ad.
But with the global transition to electric vehicles underway, there is now a threat looming over the future of the German automotive industry. Europe’s largest economy is more dependent on gas-powered cars than is commonly realized, and because of how its economy is structured, transitioning to electric vehicles will be more difficult than most people imagine.
The transition to electric cars is going to completely upend Germany’s economy—and probably not for the better.
Germany’s Automotive Reliance
On paper, the German auto industry represents approximately 10 percent of the country’s GDP. But even that figure is an underestimate of its economic centrality. A Germany Trade and Investment report found that the auto industry generates nearly 24 percent of all German domestic revenue and 35 percent of its R&D. Automotive employment is usually described as employing 800,000 people, but that is merely the number directly employed in motor vehicle manufacturing—another 1.8 million jobs are indirectly tied to the automotive industry, with some estimates even higher. Volkswagen, Germany’s largest car company, is also Germany’s largest employer overall. Most notably, Germany’s automotive employment estimates have remained stable even as manufacturing employment has fallen by some 10 percent since 1991, meaning that cars are a higher share of manufacturing employment than twenty years ago.
The German economic system is efficient partially because it is based on a highly tracked society that starts sorting workers at the earliest possible ages. As early as 10 years old, children are put onto tracks that determine the rest of their lives: whether they go to university or learn a trade. From there, Germans that are not on the university track are predominantly taught the skills needed to fit into the industrial complex, rather than a more comprehensive education.
If they go to university, they will likely earn a functional degree designed to meet the needs of a Volkswagen or a Merck. If they don’t, they will probably work at a Mittelstand, a small or mid-sized business that accounts for 52 percent of German GDP, 70 percent of employees, and 82 percent of trainees, in contrast with the United States, where only 46.4 percent of all employees are employed by small businesses. Mittelstands are often family-owned; on average, the owner is 57 years old and the company is 70 years old. But with this stability comes brittleness—Germany’s long-term unemployment rate is well above the OECD average.
The German automotive sector relies heavily on the Mittelstands for industrial power components, specialized parts, and chemicals, and they contribute up to 70 percent of the value-add for a manufactured vehicle. Without this automotive demand, many specialized Mittelstands would go out of business, causing significant knock-on effects. German engineering is well-regarded not just because of its quality but also because of its value—the customer pays a reasonable price for an excellent product. Without the subsidy of automotive demand, German products in other industries that share manufacturing supply chain nodes would have to command premium prices to make similar profits, putting them in competition with higher-end goods.
Cars are Germany’s most differentiated products: they leverage the unique strengths of German innovation to create products with an outsized surplus value. Because of this, auto industry patents make up 47.5 percent of Germany’s patent applications and Germany exports 75 percent of the cars it produces. That makes cars the greatest share of German exports at a whopping 15.3 percent, which is 1.5 times more than the next largest category: chemicals.
Germany’s economy is structured around an assumption of high exports, especially in the automotive industry. Germany has benefitted from the cheap euro of the 2010s because its export-driven economy allows it to maintain a significant current account surplus. One paper found that the top driver of this surplus was a high demand for capital goods—cars. Without the auto industry, it would be impossible to maintain it, and by extension fund Germany’s welfare programs.
Germany’s reputation for automotive engineering prowess is so potent that it is widely assumed that German engineering can be applied to any domain. German companies cultivate this assumption with promises like BMW’s commitment to spend $34 billion dollars on “future-oriented” technologies.
But this is not always the case—manufacturing is not a generic input into a production function. Building battery electric vehicles (BEVs) is vastly different from building internal combustion engine (ICE) vehicles. The reason is that BEVs and ICE cars are built around highly distinct—and incompatible—propulsion systems.
Because of the vast number of specialized parts, ICE cars depend on supply chains that are more specialized than they first appear. Modern ICE engines are very complex, with specialized mechanical subsystems for everything from compressing air, combusting fuel, and managing exhaust to balancing the vibration of the engine and changing gear ratios. As such, a combustion engine has 30 different types of main parts, from engine valves and intake manifolds to piston rings and spark plugs. Each of these has its own requirements like specific lubricants and operating fluids, each with their own supply chains.
By comparison, BEVs are much simpler. Their massive battery packs are heavier than an ICE drivetrain, but they drive their high-efficiency motors directly, and the axles are directly driven by the motors with very simple, usually single-speed transmissions. As a result, an electric drive train may have just 17 moving parts compared to more than 200 for an ICE, which means that BEVs require very little maintenance. BEVs are therefore 30 percent less costly to maintain than ICE cars.
This complexity difference is related to the large efficiency difference. Besides the inherent thermodynamic inefficiency of converting combustion into motion, the mechanical nature of an ICE powertrain causes significant energy to be lost to friction and heat, and puts tight constraints on the thermodynamic design. As a result, ignoring heat loss, only 40 percent of the energy converts into kinetic energy compared to 85 percent or more for BEVs. The most recent data from the U.S. Bureau of Transport Statistics say that the average light-duty passenger vehicle has an average fuel efficiency of 39 MPG, in comparison to the EPA’s 2021 rating of 70 MPGe (an equivalent for electric vehicles) for the Porsche Taycan S, which has the lowest energy efficiency of any electric vehicle. The very high efficiency and cleanliness of converting electricity to motion in BEV powertrains means much simpler cooling and lubrication systems.
However, the reduced complexity of BEV propulsion systems is deceptive. Making an electric car is anything but simple.
If BEV manufacturing was simple, all the auto companies would be catching up with Tesla in a few years. But the difficulty of BEV manufacturing comes from different needs in software and supply chains. Battery packs are not one giant battery, but many batteries daisy-chained together. This requires complex software to prevent temperature problems, balance discharge, and optimize efficiency. In a sense, BEVs are as much software as they are cars, but software is usually considered one of Germany’s weaker areas. Indeed, Volkswagen’s BEV program was delayed for years by faulty software and still launched with hundreds of bugs.
The batteries themselves introduce their own supply chain complexities for car manufacturers. Batteries are a specialized branch of chemical engineering; Bayer can’t just transition its skills in, say, fertilizer to lithium-ion. New BEV factories now commonly involve a co-located joint venture with a battery company for this reason, also helping to reduce batteries’ high shipping costs.
Even the basic car platforms are different. BEV chassis are designed around placing the extremely large and heavy battery on the bottom of the car, under its floor. This change in basic form factor will obsolete the billions of dollars invested in current vehicle platforms with different design assumptions. The Economist reports that Volkswagen will have to create an entirely new chassis platform, and it will not fully roll out until 2030. That means that much of Germany’s nearly century-old investments in expertise and refinement must be replaced, reducing Germany’s otherwise huge first-mover advantage.
All this together upends decades of German factory floor design and supply chain relationships. It creates a new manufacturing line where the core competency is diluted away from the original equipment manufacturers (OEMs) to the battery partner. After all, the largest battery facilities in Germany are not German—they are American and East Asian. If the German automotive industry will try to naturalize battery production, they will have a lot of catching up to do.
The performance of German BEVs underlines how behind their industry is. Consider the example of “core efficiency,” a BEV metric that adjusts range to take into account weight class and battery size, isolating efficiency improvements due to engineering. Setting aside Tesla, which is in a league of its own when it comes to core efficiency, the best-performing manufacturers are American and East Asian; German manufacturers are completely at the bottom. BMW and Porsche are among the absolute worst in their weight class. Mercedes does better than the other German manufacturers but is still less efficient than Ford or Hyundai. It is staggering how absent German technology is in this mix.
Comparing Tesla to Mercedes is particularly instructive. Take the Model S, Tesla’s flagship. The Model S was Tesla’s first mass-production car, first released in 2012; today, it retails for $99,990 dollars. The longest-range model was released in 2017 and continues to undergo improvements. The EPA rated the Model S at 402 miles in range years ago, which is comparable to the average ICE vehicle range of 412 miles. The Mercedes EQS, the top Mercedes BEV, costs $102,310 and has had the advantage of learning from years of Tesla’s mistakes. The EQS is rated for 350 miles. In other words, Mercedes found that their expertise in building ICE vehicles doesn’t transfer over to building an electric car as good as a Tesla, or even a Hyundai.
Batteries tell a similar story. Germany excels in chemical engineering and is home to companies like Bayer, BASF, and Henkel. But battery manufacturing is quite complex, and non-German companies specializing in their development have run circles around their German competitors. Tesla co-develops batteries with Panasonic. Mercedes must buy its batteries from CATL, the largest Chinese battery manufacturer.
More importantly, none of these batteries rely primarily on German technology. Even if some are being made in Germany through joint ventures, they are more like outposts for American and Asian companies to access the European market. The core intellectual property is not German, and the value will mostly accrue outside Germany.
Mark Fields, the former CEO of Ford and now the CEO of Hertz, explained his company’s mass purchase of Tesla cars: “Tesla is the only manufacturer that can produce EVs at scale.” Ford, Fields’ old employer, seems to be proving him wrong with their Lightning line of electric trucks. But Ford is also American, and it’s telling that German firms aren’t even part of the conversation.
Why Germany Is Vulnerable
The source of German value is the many specialized Mittelstand suppliers that manufacture the powertrain which currently makes up around half of an ICE vehicle’s value. But the consulting firm PwC estimates that this is where the core change in the BEV value chain will be seen. The powertrain will shrink from about half of the car’s value for ICE vehicles to between 34 and 40 percent for BEVs, and will have completely different components. Instead of complicated engines, the bulk of the new powertrain value will come from the batteries themselves, implying that the differentiating value of German cars is at risk.
Mercedes and BMW, as companies with distinctive products beloved by millions and brands worth billions, will not disappear. But they will fall behind and shrink. And the automotive industry isn’t just one part of the vibrant tapestry of German engineering—beyond just the Mittelstands’ relationship with the automotive industry, car manufacturing has an outsized impact on Germany’s whole economy. Its competitive difficulties will strike at the very heart of the German economic model, and reforming it could entail sweeping changes everywhere from welfare to the educational system.
But the current economic model depends on a sector-wide consensus between the government, industry, and labor unions that leads to full employment and a dependence on export strength. This also means that industries coordinate to secure their interests, regardless of what that means for Germany as a whole, like when German employers and unions recently worked together to oppose Russian gas embargoes. Jörg Hofmann, the head of Germany’s largest union IndustriALL Global Union, or IG Metall, threatened a “ruckus” if auto companies pursue “destructive company strategies” that include economically necessary changes, like factory closures.
The power of Germany’s historic industries is not to be underestimated. Even in the face of climate change and Germany’s Paris Accord obligations, the country decided to shut down its remaining nuclear plants and replace them with coal, one of Germany’s oldest industries. ICE-dependent companies are even more powerful and may delay Germany’s BEV investment pace just as other countries are speeding up—all to protect the present at the cost of the future.
Employees will also bear the brunt of this energy transition, in part because of how highly regimented the German workforce is. Someone whose entire education led them to a specialized career will have difficulty retooling for another part of the supply chain, let alone a different career. Germany’s engineering system is considered the best by many Europeans, but when those engineering skills are in less valuable fields, the lack of flexibility becomes a weakness and not a strength. A report by the Boston Consulting Group and Agora Verkehrswende forecasted that in 2030 Germany would have approximately the same number of jobs as today even though they also predict a nearly 50 percent turnover, with half those jobs classified as having “partly high training requirements.” It is difficult to square those two predictions.
It would be difficult for any economy to absorb such drastic change, let alone one as structured as Germany’s. The government-backed German Economic Institute reported that the government’s Kurzarbeit furlough scheme, which pays 60 percent of a worker’s lost wages if an employer reduces their hours instead of laying them off, was not enough in the face of COVID-19; if the German auto industry shrinks and causes many Mittelstands to fail, the cost of hundreds of thousands of Germans on the dole will be challenging to absorb.
Where the Future Lies
The fundamental issue is that the BEV revolution strikes at the heart of Germany’s differentiating value. This is not the end of German OEMs or evidence that Germany has no engineering or value advantages. But in the near future, with simpler electric vehicles, it isn’t unreasonable to imagine that high-end car companies will focus more on marketing if their engineering cannot catch up. It’s been done before—Ferrari has a higher market capitalization than Fiat Chrysler, which spun it off. But nearly half of Ferrari’s revenue is already high-margin merchandise.
The impending transition to electric platforms does not mean that German companies will be unable to make cars, but it minimizes a core source of differentiation that allows the German industry to maintain pricing power and sales dominance, which means less prosperity to spread around the rest of the economy. German automotive sales growth in the 2010s was driven by China, which plans for EVs to be 40 percent of its market by 2030. In 2022, Volkswagen lost the top spot in Chinese sales to BYD, a homegrown brand, for the first time. In electric vehicles other than Tesla, the top ten brands in China are all local. If this trend continues as China approaches its EV goals, that portends poorly for Germany’s export model—they just won’t be able to keep up.
This threat to the German export model could also change the country’s relationship with the European Union. Germany depends on exports to drive its current account surplus, which itself relies on a weak Euro. Some economists have considered this a threat to the Eurozone economy as a whole, but Germany’s strength has nonetheless allowed it to exercise outsized control over the European economy, like during the Greek debt crisis. The rest of Europe would likely relish the opportunity to lessen German economic influence to weaken the Euro and allow more lenient debt rules, accelerating Germany’s decline. This would put Germany in greater competition with France for pan-European influence. If it proves impossible to shore up its competitive export machine, Germany may choose to engage in another sphere of competition. The most obvious one is military affairs, where Germany is already starting to increase its spending as a result of the war in Ukraine. Conveniently, military spending also functions as a domestic subsidy for its current industrial base.
But perhaps the most important risk of the BEV revolution is to the German psyche. Indeed, after the First World War, historian A.J.P. Taylor observed that “the most serious blow inflicted by the war economically was to men’s minds, not to their productive powers.” German identity is built around their remarkable work ethic and their long devotion to their historic industries, and modern Germany’s sense of pride is built on applying those virtues to automotive exports, not just its economy.
Just as losing their historic coal and iron industries in the 1920s led Germans to doubt their governance model, so too may the decline of the car industry throughout the 2030s lead Germans to question their economic model like the U.K. in the 1970s. Then, the British experienced an economic slowdown and hollowing out of historic industries like shipbuilding, resulting in waves of union strikes, civic unrest, and ultimately the Thatcherism of the 1980s. It isn’t unthinkable that a similar economic situation could lead to similar disturbances and overhauls. Whatever the outcome of this transitional period may be, the German economy of the future will be vastly different than that of Germany today.