By Michael Heise

The German experience

FRANKFURT Globalization is biting at the heels of the United States. For years an aggressive advocate of greater openness to trade and investment flows, the United States today is faced with a situation where it must respond to new international challenges.

That scenario is one with which Germans are well familiar. Germany's moment of truth occurred in the mid-to-late 1980s, when its industry found that because of cost pressures from abroad it no longer commanded as powerful a market position as it once did in key export sectors such as cars, chemicals, pharmaceuticals, electronics and especially machine tools. In the wake of this development, some branches, like consumer electronics, virtually disappeared.

At the time, it was U.S. and Japanese competitors who put a mirror to the face of German industry. German manufacturing came under tremendous cost pressure. This came as a shock to many Germans, who had believed that Germany's strong system of vocational training and its focus on value-added and high-quality production made its position in the manufacturing sector almost unassailable.

The current worries in the United States about India fall into a similar category. The reason why the outsourcing of well-paying service jobs is so painful is that it is hitting the United States right where it thought its comparative advantage was most robust.

Twenty years ago, we all lived in a simpler world. One could roughly identify "goods" with "tradables" - and "services" with nontradables. Today, the Internet and satellite communication are rapidly breaking the geographical constraints on almost all services. In addition, the U.S. economy is exceptionally dependent on services, with 64 percent of men and 86 percent of women employed in those sectors. The comparable numbers for the 12 member countries of the euro zone are 54 percent and 80 percent, respectively. In Germany - the least service-oriented of the advanced economies - the numbers are 50 percent and 79 percent.

Some of the highly qualified service activities that the United States has dominated - software production most notably among them - are facing fierce new competition from Russia, China and especially India. But lower-tech services - such as call centers and medical transcription - are similarly feeling the heat.

The new competition in services is here to stay. Just as Germany awoke in the 1980s to find its prized manufacturing and machine tools sector could no longer dominate its rivals across the board, the United States is finding today that service activities it thought were locked into place are footloose and looking for a better deal.

The German story, though, is ultimately a heartening example for the United States. Rather than retreating into protectionism, German industry was pruned by the shears of competition. That process allowed the survival of only those companies and products that were doing well in international competition.

The German share of world exports is still far greater than the Japanese share and about the same as that of the United States. The adjustment strategy entailed efforts to bolster productivity, to focus on profitable areas and to foster distribution and retail activities.

But another strand of the story was a surge in outward investment. Part of that was focused on distribution activity, but a large fraction also meant export of jobs. This triggered decades of discussion about the merits of globalization. But at the end of the day, the German case does provide evidence in support of the thesis that foreign direct investment is a way of keeping companies competitive in ever-fiercer markets.

Germany's adjustment process was painful, but worked even within the confines of inflexible German labor laws, tough environmental standards and sluggish domestic economic growth. America's greater flexibility and more robust growth should make it easier for U.S. companies to adjust to new realities and find ways to employ those workers - many of them highly skilled - who were displaced by outsourcing.

That is how competition is supposed to work. Some companies will go bankrupt and some products that had been produced domestically will be imported, but new companies and products will prosper. That is the lesson America has long advocated when it urged other countries to open up and reform their economies.

The United States is now being tested not only to see whether its actions match its rhetoric, but whether it can take politically difficult steps that will ultimately benefit its economy - and its claim to global economic leadership.

Michael Heise is chief economist at the Allianz Group and Dresdner Bank. The German experience

International Herald Tribune