By chiefly focusing on trying to salvage its industry champions, German policymakers may have overlooked the untapped growth potential of the country's services sector.

The German economy, once described as Europe's growth engine, has underperformed euro zone peers since 2018 and faces further pain amid plans by car giant Volkswagen to shut factories at home.

Adding to such woes, Germany's governing coalition collapsed on Wednesday after Chancellor Olaf Scholz sacked his finance minister, capping months of wrangling over budget policy and the direction of the economy.

While Scholz favoured putting a lid on energy costs and funding state-backed measures to save jobs in the ailing auto sector, pro-market minister Christian Lindner wanted spending cuts, lower taxes and less regulation to allow Germany to keep its "industrial heart."

Yet, Germany needs to start focusing on its services sector, which is smaller than in comparable European economies but growing faster than the country's manufacturing segment, according to Reuters interviews with 12 executives, entrepreneurs and economists.

"If you can do something to boost a bit the services sector, it could overcompensate for the shrinkage in manufacturing," said Guntram Wolff, senior fellow at think tank Bruegel and professor of economics at the Université Libre de Bruxelles.

Services, which range from hospitality to finance and IT and already make up the bulk of Germany's economy, grew 1.6% in the first half of this year from a year ago, while manufacturing contracted by 2.8%, data from the German Economic Institute IW showed.

The services sector represented 70% of Germany's gross domestic product last year, against 78% in France, 72% in Italy and 75% in Spain, according to Eurostat data.

Business executives and company founders believe a suffocating bureaucracy and a culture of heavy regulation is stifling the creation of new companies and new jobs, particularly for small and mid-sized businesses that together account for 55% of Germany's workforce.

Leonard Benning, a serial entrepreneur and co-founder of fintech lending company Selina Finance, said opening up his company in Britain was painless as he could legally establish it online and get a tax identification number in a matter of days.

However, when he launched a business for purchasing and running vending machines in Germany, called DAP GmbH, the same processes took him more than four months and endless paperwork involving authorities and tax accountants. It also cost thousands of euros against just 50 pounds ($64.57) for his UK firm, he told Reuters.

While red tape is a problem across the whole economy, 56% of respondents to a services sector poll by the German Chamber of Commerce and Industry (DIHK) published on Oct. 29 listed regulation as their main concern. German industry sector respondents, on the other hand, listed risks to domestic demand as their main worry, along with energy prices, according to the same survey.

Lengthy and costly certification and approval procedures prevent small and young companies from entering the German market, particularly in the financial or health sector, said Daniel Breitinger, an executive in charge of startups at Bitkom, the German association for the information technology sector.

"The result is that innovation takes place in other countries," said Breitinger, whose association represents 2,200 companies.

BARRIERS REMAIN

Overregulation is also exacerbating a labour shortage, with 50% of companies active in Germany's services sector saying they struggle to find workers, according to a 2023 report by DIHK.

Many services sector professions, including lawyers, accountants and doctors, require specific legal standards and certificates to practice. But in Germany the requirements appear to be stricter and affecting a wider range of jobs. The country has 33% of the total workforce employed in regulated professions, well above an EU average of 21% and the highest proportion of any EU member, data from a 2021 European Commission report show.

Marcel Krieb, managing director at Pretium Associates, said Germany's strict employment qualifications make it difficult to find young new hires for his firm, a financial consultancy for mid-sized companies:"We are the country of titles," he told Reuters.

Only 1.4% of German-based auditors are under 30 due to the long training requirements, while 31% are between 50 and 59, according to a July report by the German Chamber of Public Accountants.

Overcoming such barriers requires getting policymakers' attention.

But while manufacturers can count on the mighty business lobby BDI, which describes itself as 'The Voice of German Industry', the domestic services sector is extremely fragmented and represented by a myriad of small associations, Krieb and other executives lamented.

Tellingly, Germany's statistical office publishes more than 20 monthly datasets for the industrial sector, including very detailed figures for the automotive, chemical and pharmaceutical sub-segments. But monthly figures pertinent to services looks limited to retail sales, people employed in the sector and turnover in accommodation and food services.

For Cyrus de la Rubia, chief economist at Hamburg Commercial Bank, the scarcity of data is the best example of the scant attention paid by politicians to this crucial part of the German economy.

"It is a demonstration of a biased view on the economy," de la Rubia said.

($1 = 0.7701 pounds) ($1 = 0.7744 pounds)

(Reporting by Maria Martinez, Editing by Lisa Jucca)