The Factory Of Factories

But that's only the well-known part of the story. Much less familiar are the global trends that German companies have been able to leverage in their favor. First and foremost is the Return of the Old Economy. Contrary to popular belief, it's not IT or made-in-China consumer goods that have driven world economic growth since the turn of the millennium. That's because the 1990s boom in IT—which benefited countries like the United States and Japan—has fizzled as prices for tech hardware have fallen.

Similarly, services have been stagnating at roughly one fifth of world trade for years. Instead, there has been an unprecedented surge of equipment-buying in emerging economies, as countries from China and Russia to the Middle East build factories, upgrade transportation and improve infrastructure—a trend economists expect will last years, if not decades. Developing and transition countries have accounted for more than a third of German export growth since 1995, and in 2006 Germany even managed to run an €11 billion trade surplus with these countries—€21 billion if energy suppliers like Russia and Kazakhstan are factored out.

Even as other Western countries have shrunk their industrial sectors, Germans have been expanding market share vis-à-vis their rivals in these strongly growing areas. That's the main reason Germany's manufacturing-heavy DAX Index soared 22 percent in 2007, 18 points more than the S&P 500 and Britain's FTSE, 21 points more than France's CAC 40, and 33 points more than Japan's Nikkei. Behind the gains were export powerhouses such as carmaker Volkswagen (up 82 percent) and industrial conglomerate Siemens (up 44 percent). "China may be the world's factory," says Hermann Simon, CEO of a German consultancy advising exporters. "But German companies are building it." And they're finding it quite profitable to do all that building at home.

The second global trend contradicting the familiar public debate over globalization and outsourcing is the way companies increasingly compete on quality, not just on price. "We all expected China to move into certain sectors, forcing Germany to specialize in something else," says Yale trade specialist Peter Schott. Instead, economists have been astonished to see German companies stay put and even thrive, as they compete in the same products as China. The obvious conclusion, says Schott, is that more-expensive German goods have something customers want, such as better quality or services like lifetime maintenance, systems integration and upgrades. That's why Germany dominates the global markets for exotic factory machines from cocoa processors and carton creasers to warp knitters and lipstick fillers (in each of these niches, a single German company controls 70 percent or more of the global market). The new view, says Schott, is that as long as German workers stay up on quality, they can insulate themselves from Chinese competition.

One indication that German companies aren't waiting for China to catch up is that the premium customers are willing to pay for German products has been steadily rising. Germany's export prices to the United States, the world's largest importer, have risen twice as fast as China's since the late 1990s, even as Americans order more German products. In France, Germany's biggest export market, the German premium has risen even faster even as exports have gone up. Schott says that the widening price gap reflects quality upgrading, as German firms specialize in ever-more sophisticated versions of products.

Take Dorma, the world's leading manufacturer of what seems, at first glance, a lowly and exchangeable product: door locks, hinges and glass walls. Yet it's one of Germany's fastest-growing global companies, delivering to construction sites from Shanghai to Dubai.