What if Germany stopped making cars?

The prospect of Volkswagen dying like Nokia is unlikely but is no longer a fantasy as the German auto industry faces many challenges.

“The future of the Volkswagen brand is at stake,” Thomas Schäfer, the company’s new CEO, told the company’s management team in early July. Rather than sugarcoat it, he acknowledged high costs, falling demand and growing competition.

“The fire has reached the roof,” said Thomas Schäfer, echoing Stephen Elop’s famous warning after taking over as Nokia CEO in 2011. At the time, Nokia was still the world’s largest mobile phone maker, but he described the company as a burning platform.

In Nokia’s case, the warning came too late. A few years later, the company was dissolved and its mobile phone business was sold to Microsoft. So could the Volkswagen brand and its nine-brand parent, or even Germany’s mighty auto industry, suffer a similar fate? And if so, what does it mean for Europe’s largest economy?

Of course, a near-term collapse is unlikely. Volkswagen is the world’s largest automaker by revenue in 2022. On July 27, it reported an 18% increase in sales in the first half of 2023 compared to the same period in 2022, to 156 billion euros ($174 billion). BMW and Mercedes-Benz, Germany’s other two major car companies, are also in good shape.

A technician attaches a Volkswagen logo to a car at a production line in Zwickau, Germany, April 26, 2022. Photo: Reuters

But disaster is no longer unthinkable. German industrial leaders are genuinely worried about the future. By July, business confidence had fallen for three straight months, according to the Ifo Institute. In addition to Schäfer’s concerns, companies are complaining about red tape and geopolitical uncertainty in trade with China.

Automakers face these challenges more than most, as they are undergoing a transformation. They must electrify their fleets and learn to develop software. As these trends unfold, much of the added value may come from elsewhere. Industry insiders acknowledge that factories will shrink or even close. So will many suppliers, especially those that make components for internal combustion engines and transmissions.

The challenge in China is also growing. German cars have benefited from the country’s rapid growth in recent decades. In the second half of 2022, the big three German car companies earned about 40% of their sales there. But now they face a reversal.

Volkswagen has just cut its global delivery forecast, largely due to slowing sales in China. Geopolitics are likely to make things worse. Chinese rivals have begun to expand abroad, especially in Europe. Last year, China exported more cars than Germany for the first time, about 3 million compared with 2.6 million. At Volkswagen, electric vehicle orders are 30% to 70% below plan, depending on the brand. The company is still working out software issues. In China, Volkswagen has just 2% of the electric car market.

How important is the auto industry to the German economy? Auto production directly employs nearly 900,000 people in Germany, or 2% of the total workforce. Two-thirds work for car companies and the rest for suppliers. Nearly three-quarters of passenger cars sold under German brands are now made abroad. Last year, just 3.5 million vehicles were produced domestically, about the same as in the 1970s.

Cars account for 16% of German exports. The industry’s share of total value added peaked at 4.7% in 2017 and fell to 3.8% in 2020, according to the Kiel Institute. That’s about a percentage point higher than other auto-producing powers like Japan and South Korea.

But looking at the auto industry in such a narrow way is not enough. Oliver Falck, director of the Center for Industrial Organization and New Technologies at the Ifl Institute, likens it to a kind of “operating system” for the economy. “Key components of the German economy and the institutions that rely on it,” he says.

According to research by Thomas Puls of the IW consultancy, global demand for German cars accounts for more than 16% of the value added of the country’s metal crushers and plastics manufacturers. This indirectly creates another 1.6 million jobs, bringing the total number of people supported by the auto industry to 2.5 million, or more than 5% of the workforce.

Germany’s investment and innovation are tied to the automotive sector. The industry accounted for 35% of total fixed capital goods in manufacturing in 2020, provided more than 42% of manufacturing research and development (R&D), and accounted for 64% of corporate and institutional R&D budgets, according to 2021 figures from the Stifterverband research fund association. According to the IW, automakers accounted for nearly 50% of corporate patent filings in 2017, up from a third in 2005.

The auto industry is also central to the regional model of social equality. Factories are often built in economically disadvantaged regions. Of Germany’s 400 cities and counties, 48 are heavily dependent on auto jobs. If the auto industry were to collapse, Germany would face “multiple local crises,” says Wolfgang Schroeder, a researcher at WZB.

The union-employer relationship also relies on the auto industry as its backbone. IG Metall has around 2 million members, 90% of whom work in the auto industry. The union’s power helps it negotiate better wage deals, which can have ripple effects in other industries. Sebastian Dullien, an economist at the Hans-Böckler-Stiftung, a trade union think tank, says the collapse of this order would alter the balance of the German labor market.

Overall, the disappearance of the German auto industry would “leave a huge economic hole in the middle of Europe,” according to WZB’s Schroeder. Of course, politicians won’t let that happen. But Rüdiger Bachmann, an expert at the University of Notre Dame, also thinks that German officials should put a little more faith in other market forces to replace the weakening auto industry.

Even Christoph Bornschein, CEO of consultancy TLGG, argues that Germany’s once-powerful auto industry is increasingly holding the country back. “Cars are the greatest manifestation of Germany’s single-minded focus on mechanical engineering,” he says. “The problems with Volkswagen’s software unit show that an economic system optimized for creating expensive mechanical marvels will struggle to innovate in an increasingly digital world.”

Once the car industry is no longer dominant, there will be more room for alternatives. Fewer subsidies will flow into the sector and more capital will flow to startups. Fewer young Germans will study mechanical engineering, opting for computer science. Researchers will put more effort into developing mobility services rather than filing yet another car-related patent.

The liberal approach has worked for Eindhoven, a Dutch city once dominated by electronics giant Philips, much like Volkswagen is now in Wolfsburg. Eindhoven is now home to thousands of small companies, most of which are suppliers to ASML, Europe’s leading maker of advanced chipmaking equipment. Espoo, still home to Nokia, which today makes telecoms network equipment, now has a thriving startup ecosystem.

Admittedly, making cars is much more complex than making electronics. But the gradual shift will create adaptations. For example, big suppliers like Bosch and Continental will do more work for foreign automakers. And Germany could stop making cheap cars and focus more on a small number of higher-margin luxury cars. Volkswagen could even turn itself into a contract manufacturer, assembling electric cars for other brands, much as Foxconn assembles iPhones for Apple.

Some inside and outside the industry are already imagining a future without Volkswagen, at least the kind of one it currently exists in. Andreas Boes, of the ISF Munich Institute for Social Science, argues that the company needs to stop building its strategies around cars. Instead of making cars more comfortable, so that people spend more time in them and buy additional services, he suggests, companies should aim to organize mobility more holistically, in new and clever ways.

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