Instruments and Institutions of Industrial Policy at the Regional Level in Germany: The Example of Industrial Defense Conversion
Elsner, Wolfram, Journal of Economic Issues
Severe structural change, such as that caused by the contraction of the defense industry since the end of the Cold War, often produces high social costs. These costs include the loss of production and system capacities, skills, and key technologies in individual regions. On the other hand, such capacities and capabilities are very often established in other regions at the same time. Such processes frequently appear to be efficient from the individual company's point of view but seem societally inefficient.
The management of structural change, i.e., active preservation as well as modernization of existing economic structures in a region is a form of conversion. However, management of structural change not only occurs infrequently, it may actually result in sethacks in the process of structural change and, consequently, higher social costs, widespread skepticism, disappointment, frustration, and political lethargy toward structural problems.
Such a turn of events can be observed on a large scale in the defense industry. The conversion process started in Central and Eastern Europe in the 1980s and was accompanied by high expectations. However, today the strategy of change management and the mere word conversion have become discredited. The sectors where conversion originated are also proof of the dangers of such sethacks: widespread disappointment and structural-political lethargy have led to individual and uncoordinated strategies. The danger of a drastic increase of uncontrolled weapons exports to regions of conflict and the sale of weapons in the domestic market have increased. There is also increased pressure on Western defense companies to export their military hardware.
Against this background, questions regarding whether and how the challenge of a severe and often sudden structural change can be overcome in a particular region takes on added importance. In this paper, I will attempt to show that conversion--taking the defense industry as the point of departure--is feasible as a form of successful management of structural change. I also argue that this management process might be transformed from a more-or-less marginal form of industrial change to a general form applicable not only to change in the defense sector, but to severe structural change in general. Sectoral cooperation, regional "networking," as well as carefully balanced structural policy support using financial and nonfinancial instruments, is required. If different elements can be brought together in a carefully balanced overall system, then there is the chance for further development of regional industrial policies and, at the same time, for the generalization of conversion as an answer to the challenges of structural change.
Terminology and Conceptions
As conversion support is not yet a well-defined area of economic analysis or policy and belongs to a field in which practical experience--at least in Europe--has only recently been obtained, further clarification is necessary.
Conversion is generally one of several forms of structural change and is actually a special case. Conversion of an industry usually has to compete with seemingly more favorable alternatives such as trying to get a bigger share of a shrinking market, export strategies, concentration by closing down production sites after acquiring or establishing new sites in other regions, or simply the "strategy" of hanging on and muddling through. An appropriate definition of conversion should include not only the serving of new markets--this would simply be diversification, which in the case of defense production is often called "dual use"--but also new markets for new products that are to be manufactured with new forms of production processes.
There is no particular branch of industry that can be unequivocally classified as a defense industry. On the contrary, the defense industry is a cross section that appears at different places of industry statistics. When such a "cross section" is heavily represented in a region, this is of vital concern for the region. On the other band, it is precisely the high-tech parts of the defense industry that do not often cooperate with regional sub-suppliers and other companies in the region. This may be because of official secrets and regulations and because of specific quality requirements, i.e., the fact that they have to process highly specialized components that can often only be obtained from a few suppliers throughout the world. As a consequence, defense conversion raises interesting problems for regional integration of the economy and for innovative potential.
Modern industrial policy must deal with broadly defined and interrelated sectoral complexes. Such complexes consist of manufacturing and services that are closely connected. The defense industry, for instance, is an interrelated complex. For example, in the case of systems such as "ships" or "aircraft," it involves many different suppliers, sub- suppliers, and service companies.
If interrelated complexes are considered as capable of further development, i.e., as a potential core of future regional development (as "growth poles" or "key industries"), then specific industrial policy support should be provided. Due to its technological potential and cross-sectional character, the defense industry, for instance, has the potential to be a core of regional development. However, at present this potential is often not seen because of its relatively isolated position in the regions.
Elements and Relevance of the Bremen Approach to Regional Conversion Policy
Bremen's conversion approach has, in recent years, attracted some attention as a model for regional industrial policy. It can be described as a "package" containing the following elements [for a more detailed description, see Elsner 1992 and 19931. The state of Bremen had a high regional dependency on defense both from a quantitative (jobs, net output) and qualitative (innovation potential, qualification level, system capabilities) point of view and high regional vulnerability to disarmament. According to a 1992 EC-study [EC 1992], Bremen ranked third on the list of the EC regions most dependent on defense industries. At the start of the conversion process in Bremen in 1989, 16 percent of the industrial work force were employed either directly or indirectly in defense-oriented companies. Furthermore, according to estimates, about 50 percent of R&D in Bremen was carried out by defense contractors. Bremen was already suffering from structural decline in shipbuilding, steel productions, and fisheries.
It is not surprising, given this, that there has been considerable political emphasis on conversion in the region. A number of defense companies have their headquarters in Bremen and are in this way tied to the region. There was quick reaction to the regional statistics on national defense procurement first published in 1990, which highlighted Bremen's defense dependency as compared to other German states. The compilation of the comprehensive Bremen Disarmament and Conversion Report in 1990/1991 was a social process involving company managers, company employees' representatives, and business and employees' chambers and associations. Prior to this time, business representatives had not actively participated in conversion discussions.
There was relatively rapid planning, political discussion, and finally the formal adoption of the Bremen defense conversion program in 1992 with support guidelines for companies. These contained a regional economic approach for supporting structural change. The program applied instruments, experience, funds, and projects of the existing comprehensive Bremen program for structural policy (which employed approximately 300 million DM/$188 million yearly). It did, however, contain some new aspects of regional industrial policy.
There was also a relatively rapid opening of the doors to financial sources in the EC through participation (with the regions of Lancashire in the United Kingdom and Zaanstad in the Netherlands) in the first, small, interregional cooperation network (named DEMILITARIZED) funded by the EC. This network proposed long-term support of conversion to the EC Commission in 1991 [BAW 1991]. Other sources include the participation of Bremen in the EC program PERIFRA in 1992, an initiative program for the EC ad hoc program KONVER in 1993, and Bremen's bid for the EU community initiative named KONVER 1994-1997. Parallel to this, there was discussion with the "competition watchdogs" of the EC Commission about company support in Bremen's conversion program. The results have, against all expectations, facilitated active industrial conversion support.
The formation of a consultancy committee for the Bremen conversion program in 1993 resulted in an integrating force and led to cooperation among chambers, employers' associations, unions, university representatives, and representatives from the peace movement, with company management and workers' councils. Medium-term company conversion programs to last from three to five years, as well as more detailed short- term company action plans of company conversion lasting for a period of from one to two years, were developed. An inter-departmental control committee consisting of representatives from the departments of science and technology, environment, labor, and economic affairs was formed. And, the external consultants for technological evaluation of projects and the establishment of a periodic overall evaluation and updating of the program were provided for.
In spite of these achievements, it should be noted that the Bremen conversion program is a financially small program. Though it has expanded and might further expand in the future within the framework of the EU community initiative called KONVER, it will nevertheless remain a small program. We have, up to now, budgeted 18 million DM/$11 million for 20 projects, the majority of which started at the end of 1993. Conversion support has remained, up to now, of limited importance. In the 11 defense- dependent companies located in the region, as well as in one large defense-dependent research institute, jobs directly dependent on defense work declined by about 21 percent in the four years between the beginning of 1990 and the end of 1993. However, greater challenges (i.e., job losses) lie ahead that will test the real effectiveness of the program. More than 50 percent of the job losses resulting from defense cuts have been reclaimed by the production of nonmilitary products. This relatively high "conversion rate," however, reflects, to a certain degree, the efforts of companies to keep personnel and provide them with nonmilitary R&D work. Several companies have yet to determine long-term targets. A significant majority of the converted jobs have been converted without public support. This has resulted from market processes that have favored such activities as civil aircraft manufacture and yacht construction. Statistics show that, up to the end of 1993, we had only been able to use conversion funds to assist in the transformation of approximately 250 jobs. The vast majority of these jobs were in R&D. Although the economic significance of support for the region does not end with the number of safeguarded and created jobs, and although this number is increasing and will expand in the near future, I have nevertheless mentioned these numbers to dampen overly high expectations.
The relevance of Bremen's program and its approach to industrial defense conversion should be seen therefore as an industrial policy program that can serve as a framework for experimentation and learning for the further development of industrial policies in the regions.
Successes and Problems of Applied Regional Industrial Policy
Against this background, there are a number of analytical and policy questions to be asked. Table 1 gives an overview.
[TABULAR DATA 1 OMITTED]
Economists normally inquire about the market position of the individual company. Our first question is, accordingly, what is happening to the relevant markets and what are the strategies employed by the companies to react to the market changes? As has been mentioned, companies do not automatically react with a conversion strategy when confronted with contracting markets, even when new civil markets are expanding at the same time. However, in Germany there has been growing uncertainty in recent years regarding the further development of markets and on the national level (at least in Germany), almost no indication of a consistent "package" of defense contraction planning and industrial policy support. "Dual use" seems, in such a situation, to be an obvious and adequate spontaneous answer. In addition, it appears to be also a synonym for "waiting" and maintaining a "strategic flexibility" to keep all conceivable options open (at least for a period of time).
If a company's defense work continually contracts--and there are cases in Bremen in which it has dropped, within a period of from four to five years, from 70 percent to 90 percent of total value added--then the question of the minimum threshold required to be active on the prime defense contractor market is raised.
When entering civil markets, defense companies are confronted with the problem that the present and future high-tech markets (e.g., markets for environmental technologies, transport technologies, or communications technologies) are often already being served by efficient, often "young," small- and medium-sized companies. Defense companies thus very quickly run into difficulties when trying to apply simple dual-use strategies due to the fact that they usually cannot compete effectively. This is also true for defense-oriented electronics firms, which predominate in Bremen. At first glance, this field appears to be extremely suitable for dual use. However, even defense-oriented electronics have to compete more and more with products originating from non-defense industries. Japanese and U.S. electronics companies have already become the main suppliers of electronic components for military systems. Defense companies have no other chance than to resort to their "core-core" competencies in order to attempt to enter the "markets of tomorrow." In doing so, the time factor often becomes critical, as fundamentally new developments, aimed at future markets that do not yet fully exist, usually require from five to seven years before the break-even point is reached. The decrease in defense markets then usually takes place faster than the recreation of new markets, and the strategies of banging on may not work.
Parallel production of defense-oriented and civilian-oriented products very often does not represent a viable strategy. Both areas of production may be suboptimal from a technical and cost point of view, and synergies between the two areas can only be exploited to a limited extent, especially when the organizational structures of the two fields start to diverge. Therefore, the expansion of the share of civilian production is normally not a continual process but requires, after the share of civilian work has reached a certain level, a jump from being a "defense contractor carrying out civilian work" to a "civil contractor carrying out defense work." Companies in Bremen, for example, became extremely active in applying for conversion support when their proportion of defense work fell from about 90 percent to about 60 percent. This caused them to apply for support to change their organizations as well as to implement massive vocational training. On the other hand, companies still having 70-90 percent defense work are finding it extremely difficult to plan an integration of their civil R&D projects, vocational training, and organizational development and to apply for support of appropriate projects. Organization changes in companies are accompanied by "mini-revolution." Group work and project organization, concurrent engineering, quality management, the setting-up of marketing and sales organizations, "civil" employee culture and a change of corporate identity, business re-engineering, and "change management" are just some of the key words used in this context.
Support of "dual use" has been purposely excluded from Bremen's conversion program, and support is limited to projects involving a high degree of innovation and that are of pilot, or model, character (although, given the trend to high-tech electronics, it becomes more and more difficult to exclude dual use). To this end, but also to limit windfall or profit-- taking effects, a new criterion for conversion support was introduced in Bremen: a medium-term (i.e., from three to five years) company conversion program or each company applying for support. The "strategic" linkages of each individual project of a company can be comprehended better in this framework. Support experts, with their project control instruments, and technology consultants are involved. Furthermore, the official responsible for the Bremen conversion program can, according to the program, consult company project groups consisting of management and employee representatives in order to discuss the structural effects of projects submitted for support. These are some of the institutional measures of Bremen's conversion program to prevent windfall or profit-taking effects and to safeguard long-term structural effects. Furthermore, we are able to operate with relatively high support quotas (up to 65 percent for fulfilling several criteria), which results in a relatively high incentive effect and, consequently, tends to limit profit-taking and windfall effects.
In the short life of Bremen's conversion program, there have already been a number of "learning phases." Initially, we only supported the technologically sophisticated developments where companies already had strengths. However, next we placed more emphasis on market aspects (drawing-up of market potential analyses, integration of pilot users and sales partners into the projects, etc.) and then on the integration of civilian-oriented R&D, training, and organizational development. Finally, we have taken the initiative with regard to negotiating on the detailed company conversion action plans. Nevertheless, there is a considerable requirement for backup research to assist in determining what, for example, strategic projects" are. With the aid of relatively small amounts of support funds, such projects are supposed to achieve a maximum and irreversible "structural effect" (i.e., a long-term shift to civil structures) within a company, not only in the course of time, but also on a broad scale.
From a microeconomic aspect, the question is what strategic scope for action exists and bow far is it possible to use support to change the strategy of individual companies in favor of the ambitious option "conversion" It is possible that the market not only allows a company a certain strategic scope for action, but it is also possible that company behavior is underdetermined as a result of uncertainties regarding future market developments, due to the lack of information and overcomplexity of the decision setting. A result is that companies may welcome reliable, medium-term conversion support that has been mutually agreed on. This provides an explanation for the rather surprising fact that companies agreed to discuss and alter their action plans for conversion. Even through Bremen's KONVER program for 1994-1997, amounting to approx. 18 million DM/$11 million is relatively small, it nevertheless offers continual and medium-term support (also combined with other funds), which can be counted on and seems to be highly welcome in times of high uncertainty. This qualitative aspect influencing strategic decision making possibly lends more significance to this conversion support than is indicated by the quantitative level of direct conversion support funding.
Structural analyses of individual industries have to deal with such questions as: What parts of the individual industry are to be found in the region? Do those parts of the industry possess any relevant market power? And, is it possible by means of sectoral cooperation to expand their scope for action (toward the "conversion" option)? An attempt at sectoral cooperation was started in the defense industry in Bremen, but unfortunately this "Bremen strategic initiative for environmental protection" was abandoned before work really got underway. On the other hand, significant segments of the defense industry in the region are being integrated into one large Bremen-based company group. And some elements of the "strategic initiative" have been adopted by the EU in the so-called Maritime Industrial Forum, an idea conceived and put forward by this large company group. At the same time, though, traditional competitors in certain areas of technology--with gentle persuasion from the official for defense conversion--are beginning to coordinate their efforts in certain closely related conversion spheres and to work jointly on project applications.
At the industry level, the Bremen conversion program primarily utilizes qualitative instruments, i.e., "communication," "coordination," and the creation of a conducive "climate." Financial support is given to intercompany cooperation projects with priority. It has, however, not (yet) been possible to set up a network between the various regional players on the market in the sense of any negotiated long-term horizontal cooperation; regional technology-oriented working groups do exist, however. These are run under the auspices of neutral research and transfer institutes, and representatives of the defense companies participate. "Networking" is to be more actively supported in the future, in particular when companies build infrastructures for their networks that are of supra-company significance.
Regional Economic Issues
"Networking" is of particular importance to enhance the regional economic significance of the defense industry in its conversion process. At the analytical level, more knowledge has to be obtained on the regional economic significance of the defense industry, e.g., regional contractor-subcontractor relations and consequently the regional multiplier effects of the industry. Given the high level of skills required in the industry, it is realistic to assume a high regional income multiplier of the industry. The low-level integration of the prime contractors in the region, on the other hand, would imply a low-level regional multiplier effect. Furthermore, it would be necessary to conduct an analysis of potential (transcending the known statistical definitions of the individual branches of the defense industry) in order to ascertain the chances for a more intensive regional involvement of defense companies, i.e., a stronger "opening to the region."
Support of regional "networking" is achieved by giving priority to cooperation projects between defense companies and civilian companies by the Bremen conversion program, as well as to joint conversion projects between defense companies, if possible together with civilian companies and civil research institutes. We may also raise the support quotas if, depending on the degree of "basic industrial R&D" incorporated in a project, results are produced that are of general, supra-company significance. The establishment of joint projects is an operational criterion for assuming a relevant proportion of basic industrial R&D.
We support the setting up of networks for conversion and for the integration of the defense industry in the region in particular with the aid of new specific (mainly so-called soft) infrastructures. These infrastructures are intended to contribute to the creation of a regional development core stemming from the converting defense industry, or at least with substantial participation of this industry. An example of this in Bremen is the establishment with funds from the conversion program) of a transfer institute in connection with a demonstration and testing facility at the sewage works on the one band, and with the setting up of a large environmental technology research center at the university on the other hand. Here it is possible to utilize and further develop the core capabilities of the Bremen defense industry in sensor and simulation technology or systems control in the sphere of water and wastewater analysis, censoring, and treatment. The Bremen Institute for Waste Water Technology has led to the setting up of a specialized facility for testing, research, transfer, consultancy, and training. The conversion support is integrated, i.e., there are strong project-related links to the financially larger, comprehensive Bremen program for structural policy and the Bremen 10-year investment program. These support the two related projects--the demonstration facility and the environmental research center--with funds exceeding 50 million DM/$31 million. Another example is the establishment of a West- East transfer agency financed with funds from the conversion program. It has the task of processing Bremen's conversion know-how existing on the company, as well as state, level with the aim of creating West-East cooperations. The conversion know-how may then be exportable as an independent service at a later point in time. This agency is, of course, also supposed to establish cooperation with similar agencies in other defense-dependent regions in the Western world.
In the process, we are also creating what are called "new industrial spaces" with tightly interelated industries, services, and specific infrastructures where future industrial cores can be developed [for example, Benko and Dunford 1991). An example is the development of the former Carl-Schurz U.S. army base in Bremerhaven. This again exhibits a linking of smaller conversion projects in the soft infrastructural sector (here a new maritime transfer agency in the former base) with the "hard" infrastructural, large-scale projects of Bremen's 10-year investment program. In this case, more than 400 million DM/$250 million has been committed for the redevelopment of the base over the next 10 years.
However, instruments are lacking for an impact analysis and evaluation of such "soft" infrastructure measures. Impact indicators for such measures are mainly qualitative, and even where they are quantitatively available, they cannot easily be integrated in conventional economic accounts (such as net output or employment). The effects, therefore, of such broadly based industrial policies are still, to a large degree, uncertain. These strategies are aimed at the transformation of larger sectorally interrelated complexes and, along with financial instruments, work with qualitative concepts and instruments such as the official regional consultancy committee, company project groups, the institution of the official responsible for conversion, ad hoc groups for special conversion-related issues, special advisory committees for each transfer agency, etc.
Even though an exact regional impact analysis of this approach is still lacking, it can be stated that blockages to conversion, at any rate, have been prevented in Bremen up to now and structures for cooperation based on trust have been established. It is only through the development of broad-based regional strategies with the implementation of a balanced system of regional forces that disappointment, skepticism, frustration, lethargy, and blockages to the severe industrial change needed can be prevented and structural change can be progressively managed. Participation of companies in this approach is a desired element of the whole process, and in fact we have received active cooperation from companies. This seems to be the main proof of the success of the approach.
There has been some stabilization of behavior, reduction of specific transaction costs, opening of new opportunities for action in an uncertain environment, and, in particular, the introduction of progressive structural change. This involves "politics," defined by Marc Tool as "rewriting the rules that correlate behavior, including economic behavior" [Tool 1994, 156]. What in fact has been done is a reshaping of institutions in order to initiate further progressive institutional change. This suggests that it would be most fruitful to revisit this experience within the context of the institutionalist theory of institutional change [see Bush 1987]. Moreover, it would appear that what has been presented here is a regional version of what Egon Matzner calls a policy of "context-making" and the "staging of social events" in his Clarence E. Ayres Lecture in 1994 [Matzner 1994]. All of this encourages the hope that what I have been able to show is that the Bremen conversion effort may be a regional contribution toward what C. E. Ayres called "the reasonable society" [Ayres 1961].
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This paper was presented at the Clarence E. Ayres Memorial Session of the annual meeting of the Association for Evolutionary Economics, Washington, D.C., January 6-8, 1995. The author is Director of the Bremer AusschuB far Wirischaftsforschung (BAW, Bremen State Economic Research Institute); he is also the official for defense conversion in the German Federal State of Bremen. Elsner was the Ayres visiting scholar for 1995.…
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Publication information: Article title: Instruments and Institutions of Industrial Policy at the Regional Level in Germany: The Example of Industrial Defense Conversion. Contributors: Elsner, Wolfram - Author. Journal title: Journal of Economic Issues. Volume: 29. Issue: 2 Publication date: June 1995. Page number: 503+. © 1999 Association for Evolutionary Economics. COPYRIGHT 1995 Gale Group.
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