Germany's Auto Industry Is Built on Collusion

(Bloomberg View) -- The latest attempt to cut into Chancellor Angela Merkel's formidable electoral lead is unwisely betting that Germans will forget a significant chunk of German history.

The nation's three big carmakers -- Volkswagen, Daimler and BMW -- are accused of colluding on dozens of technology-related matters. They allegedly agreed to make urea tanks too small for effective purification of diesel exhaust, among other moves that are helping to create a national furor.

A majority of Germans is now in favor of banning diesel cars that don't live up to modern emission standards, and most say the car industry, until recently a pillar of national pride, is no longer trustworthy. On Wednesday, the car industry chiefs will attend a "diesel summit" called by the government to look for solutions. That's part of Merkel's pre-election strategy, though she's not scheduled to attend. Rivals, especially the Greens and the Social Democrats, are claiming she's been too cozy with the industry bosses over the years, which makes her culpable for the seemingly endless stream of scandals. The chancellor needs to show she's got things under control so she can hold on to her double-digit lead in the polls.

A ban on old diesels -- rejecting industry calls for a software fix as an alternative -- now looks especially likely because of a Friday ruling by a Stuttgart court, which upheld an environmental group's demand for such a ban in the city. Other German municipalities are likely to follow if higher courts uphold the decision. But Merkel's government isn't likely to take drastic action to discourage carmakers from working together for one simple reason: It's the German way, no matter how much noise her opponents try to drum up.

In 1942, Heinrich Kronstein, an eminent German legal scholar who had fled to the U.S. to escape Hitler's persecution, penned two articles on the development of cartels in Germany. He described the birth of cartels in conjunction with Otto von Bismarck's protectionist policies, introduced in the late 1870 and credited with the explosive development of German industry before World War I. Companies in most industries teamed up to create common sales structures, eliminating domestic competition and making German industries internationally competitive because of their ability to dump. In 1901, 450 of such cartels existed. They made Germany a globally dominant industrial power, not just because of the way they abused their market position but because of their ability to pool research.

"For a limited period of time these research laboratories in Germany, made possible by high tariffs and the cartel system, became the most precious raw material Germany had," Kronstein wrote.

Public opinion and the courts were against unbridled competition and in favor of the cartels. The result: German exports grew exponentially. 

The arrangement wasn't without its costs, though. Kronstein wrote:

The immediate price to be paid by Germany for this staggering development seemed not too high from the point of view of the prevailing Prussian philosophy. The freedom of action of the individual disappeared more and more. Free competition, where it existed, became a fight for quotas in the future cartel, while the liberal economists in the universities closed their eyes and pretended to live in a period of free trade. Each device for the protection of the individual became unconsciously a device for control by cartel and monopoly power. The fact that freedom of action disappeared in the sphere of life in which it was supposed to be most predominant had its effect on the entire philosophy of every man whatever his place might be in the nation. 

Even after World War I was lost and the first antitrust legislation adopted, the only way to fight German cartels was to muscle in on them. Philips did so in the 1930s, suing Telefunken -- the joint venture of Siemens and AEG -- and then striking a new cartel agreement that shared control of the German and Dutch radio industries.

The Nazis, with their attempts to control prices, were all for cartels. They made businesses join forces when other kinds of stimulus didn't help. "Cartels were believed to be a form of economic organization far superior to unrestricted competition," Wilfried Feldenkirchen wrote in a 1992 study of German competition policy.

After World War II, the U.S. pushed Germany to demonopolize; its aid came at the price of establishing a liberal economic order. But German business resisted those efforts. It took years for antitrust legislation to be enacted. Feldenkirchen wrote:

US pressure was the one coherent, driving force, but it had contradictory results, with the German government wishing to resist American demands at least in detail. The breakup of the vertical combines in heavy industry very soon led to increased horizontal concentration in that field.

The German business culture led to a system of interlocking directorships at big companies that still exists today. All sorts of intra-industry agreements -- not least dealing with research and development -- sprang up, exempt from antitrust law until 2005 as "rationalization cartels" that could lead to more efficiency through common industry standards. Under the current European Union-dictated prohibition on "all agreements, concerted practices or decisions by associations of undertakings that have as their object or effect a restriction of competition," such arrangements are difficult to defend, so Volkswagen and Daimler have attempted to be proactive in reporting the car industry's dozens of technology working groups to the German and EU authorities.

The rules have changed, but the deep-down German belief that companies in the same industry can and should work together to boost their efficiency and international competitiveness hasn't gone anywhere. It would be wrong to expect Merkel, a German conservative, to try to uproot it and go to war against the carmakers. "It's about criticizing what has to be criticized at this point, but always in the awareness that this is a strategically important industry for Germany," Ulrike Demmer, a spokesperson for Merkel, said on Monday.

Germany has tried hard to erase various aspects of its history, but it's impossible to wipe the slate completely clean -- especially since certain traditions have contributed to Germany's current economic might. As the car industry tries to come to terms with tougher regulation and technological change, Merkel's government will try to steer it through the crisis as gently as it can, even though it's politically difficult.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.

To contact the author of this story: Leonid Bershidsky at lbershidsky@bloomberg.net.

To contact the editor responsible for this story: Mike Nizza at mnizza3@bloomberg.net.

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