WHAT'S GOING RIGHT

What do Chinese breweries, Brazilian water bottlers and Italian dairy cooperatives have in common? Krones AG. The German company controls a quarter of the world's market for state-of-the-art bottling equipment. It ships 82 percent of its production abroad; its order book is backlogged to the tune of 686 million euro. With revenues doubling since 1995, its 7,300 highly trained specialists in the Bavarian town of Neutraubling have grown used to working overtime.

A rare success story in low-growth, high-cost Germany? Think again. For all the cliches of Germany as the sick man of Europe, thousands of world-beating companies like Krones have made Germany the unsung hero of globalization. Driven by strong demand for its machinery, cars and industrial components, Germany surged past the United States in 2003 to become the world's No. 1 exporter. Exports jumped another 10 percent last year to a record 730 billion euro--making Germany, along with China, the only leading country to raise its share of the global market. And that's despite a soaring euro that has made German goods much more expensive.

This good news has been largely lost amid the country's prevailing mood of gloom, angst and political crisis. A shockingly heavy opposition landslide in the May 22 North-Rhine Westphalia state election has cost German Chancellor Gerhard Schroeder's Social Democrats their traditional working-class heartland. With his party demoralized by the loss--and on the verge of schism over whether to continue unpopular economic reforms or to return to socialist tax-and-spend policies--Schroeder cut short his term by a year and called for elections in late September. Some procedural hurdles remain. But with the SPD trailing the opposition Christian Democrats by 17 points in the polls, the odds are overwhelming that in barely three months CDU leader Angela Merkel will become Germany's first woman chancellor.

Companies like Krones will figure large in what is sure to be a fierce--and deeply divisive--campaign. Blamed for stagnant growth and high unemployment, a desperate SPD has already begun lashing out at German companies. Party leaders have called them "obscene" and "unpatriotic," and accused them of outsourcing jobs and exploiting hard times to drive down wages and benefits. Already, SPD chairman Franz Munterfering has promised that the campaign will force Germans to choose between the SPD's social protections and the CDU's "cold market radicalism." He, too, will have read the polls showing that 70 percent of worried Germans agree with the SPD that globalizing capitalism is "a dangerous threat to democracy."

And yet, Germany's experience proves just the contrary. If rising exports and rising company profits demonstrate anything, it's that Germany counts high among the winners--not the losers--of globalization. Yes, unemployment is high and growth low. But if Germany has a problem, says Hermann Simon, a leading German management consultant, "German companies do not." Even companies in long-depressed eastern Germany, Simon says, are reporting double-digit export growth.

So why the social split--profound popular anxiety coexisting with striking industrial success? Think of a German economy that's also split. Pressured by fierce competition abroad and sluggish domestic demand, German exporters have embraced globalization with a vengeance. Companies like luxury carmaker Porsche and shoe manufacturer Adidas have cut costs by shifting production abroad while expanding the brains of their operations at home. Machinery makers like Krones have blanketed the world with distribution and service outlets. To a degree far beyond most international competitors, German companies have adapted to a globalized division of labor--specializing in high-end, complex products less in danger of being copied, while eliminating low-value-added jobs. Thus the recent panic in France or the United States over rising Chinese textile exports hardly echoes in Germany. The reason? Germany's radically restructured textile-makers have moved into high-margin niche markets where they can compete: 40 percent of the country's production is now high-tech textiles for autos and aerospace.

At home, these companies have successfully circumvented Germany's rigid labor regulations. They've squeezed more flexible hours and longer weeks out of their workers--sometimes by threatening to move to neighboring Eastern Europe. As a result, German manufacturing wages have steadily decreased, relative to major competitors, since 2000. What's more, specialization and outsourcing have helped insulate companies when salaries do rise at home. "Volkswagen now gets so many parts from Hungary that it's not going to have much of an effect on margins if workers in Wolfsburg get [a] 3.5 percent [raise]," says Michael Burda, economist at Berlin's Humboldt University. Indeed, the payoff from streamlining and downsizing has been such that many export-oriented companies have begun to hire again. While Krones now gets cheap components in Hungary and the Czech Republic, production previously outsourced to Brazil and the United States was brought home to Neutraubling in 2003. "It turned out we increased our productivity and competitiveness by concentrating our engineering expertise in one place," CEO Volker Kronseder says. The result: 2,000 new, high-paying German jobs.

The contrast with the rest of the German economy couldn't be more extreme. Consumer confidence has been sapped by record unemployment in industries supplying local markets. Key domestic sectors, such as retail and construction, are in what seems like perpetual decline. None of the 1.3 million industrial jobs that have disappeared since 1995 have been replaced in services or other sectors, says IFO economics institute chief Hans-Werner Sinn. Accoriding to Sinn, the German economy is pathologically and structurally incapable of shifting these workers and creating replacement jobs.

The problem is compounded by uncertainty over the SPD's zigzag course on reforms. Schroeder touts Germany's export success as his own, peppering recent speeches with claims to the nation's newfound title of exportweltmeister and assuring anyone who will listen that his policies can turn the domestic economy around--if only given more time. But German voters seem disinclined, at this point, to give him that. During the upcoming campaign, Merkel will no doubt point out that these companies are prospering despite, not because of, the SPD's policies. Even at Krones, domestic orders have shrunk by 20 percent under Schroeder, the result of stagnating consumer demand as well as stringent new recycling laws that stick bottlers with higher costs. "Under the present government you never know what's next," says Kronseder.

German executives worry that the coming election could produce a serious antibusiness backlash. Instead of debating further reform, the SPD will beat the anti-globalization drum and blast corporations for "exporting" German jobs, conveniently forgetting that exports account for a third of Germany's GDP. Muntefering has exhorted companies to "create" 500,000 jobs this year. Meanwhile, the SPD has circulated a blacklist of foreign financial investors, among them Goldman Sachs and Kohlberg Kravis Roberts, accused of being "locusts" that feed off and destroy healthy German companies. Schroeder's strategy seems clear: by so unabashedly playing on Germans' fears, he hopes to trap the opposition into defending capitalism and globalization, which are deeply unpopular.

Can Merkel present a convincing alternative? Under her leadership, the opposition has slowly moved toward a clearer promarket course. Yet she lacks the radical reform agenda of, say, Margaret Thatcher. As well, powerful elements of the CDU (and especially of its Bavarian sister party, the Christian Social Union) continue to oppose more than incremental change.

So far the CDU has stayed mostly vague and stood back to enjoy the socialists' implosion. It has some of the right proposals: cut union power to set wages, slash subsidies, drastically simplify the byzantine tax code. But to get too specific might remind voters why they used to favor the SPD. Schroeder's decision to hold early elections at least spares the country 16 months of likely paralysis under a lame-duck chancellor. But whoever wins must have the good sense to preserve what's right about the German economy--indeed, what is so very right--and to tackle what's wrong.

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