Felix Michl and Philipp Stahl huddle over a gleaming new three-armed robot in the sprawling laboratory at the Technical University of Munich (TUM). The robot picks up tiny patches of carbon fiber, each less than a tenth of a millimeter thick but containing 24,000 filaments, and quickly assembles them into a triangular shape. The trickiest task, the investigators say, is to write the software that translates a 3-D computer model of any part—in this case a bicycle seat, but it could also be a medical prosthesis or an automobile component—into instructions for the robot's intricate movements, including the exact position at which the fibers will have their maximum strength and durability. When the project is completed, Michl will use it in his Ph.D. thesis, and Stahl will finish up his undergraduate studies. But the work will get a second life in German factories, including a 70,0000-square-foot, state-of-the-art BMW production facility 30 miles down the road near the medieval town of Landshut, where engineers are crafting the next generation of automobiles.

At the moment, the Landshut engineers are focused on the BMW i3, which will be the world's first mass-market, all-electric car made from lightweight components if its 2013 launch comes off as expected. The car's passenger compartment is being built entirely out of carbon composites, which researchers and students such as Michl and Stahl are helping to develop in the Munich labs. The core innovation is a new technology that slashes the production time of complex parts such as the car's side frame to as little as two minutes, making these high-tech composites affordable for mass production for the first time. Three gigantic presses, weighing in at 320 metric tons each, inject resin into the preformed carbon-fiber parts, giving them stiffness. BMW says it has a lead in this composite manufacturing technology over competitors such as Toyota or General Motors. “The knowledge we have in bringing all these elements together isn't something our competitors can easily copy,” says BMW project manager Andreas Reinhardt.

That may be. The steady pipeline of innovation that runs from university and government research labs to manufacturers such as BMW is one of the secrets driving the booming German economy. Long belittled as lowly metal bending, German manufacturing sailed through the financial crisis with hardly a dent in profits and employment, even though its workers, among the world's most highly paid, make 10 times what their Chinese counterparts earn. German exports have held their share of the global market against China and other emerging countries, even as the U.S. share has plummeted. Rising industrial employment is one reason Germany, as of May, had a jobless rate of only 5.6 percent compared with America's 8.2 percent, according to the Organization for Economic Co-operation and Development. German manufacturers have stayed globally competitive because their products—like the BMW i3—are chock-full of science and innovation.

One major factor for Germany's success is that it has managed to tap homegrown scientific research and expertise to move up the technological ladder, concentrating on innovative products and processes not easily copied or undercut by cheaper wages. The textile industry is a case in point. Like America, Germany long ago lost the bulk of its clothing and fabrics manufacturing to cheaper locales such as China, India and Turkey. Still, German companies kept a commanding share of the global market for the ever more complex machines that weave, braid and knit textiles, riding the investment boom in low-wage countries. Meanwhile many of Germany's former textile makers also went high-tech, shifting their specialty to industrial textiles for the automotive and aerospace sectors. Today the national textile industry is at the forefront of composites research, cooperating with universities and government tech centers to develop the precision machinery that braids the carbon fibers into strands—not unlike wool or cotton, except on a microscopic scale. Had Germany given up this industry, it would lack the basis for producing those next-generation composites now being developed at TUM and other labs.

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The key for getting this research out of the lab and into the marketplace is the close partnership between research at the universities and today's high-tech factory floors. Most German manufacturers have rich budgets for research, which they often buy from others. Unlike many American firms that might fund a professorship or make a general donation to a university department, German companies usually approach universities with very specific problems they want solved. At TUM, for example, the composites department is funded by SGL Carbon, a German maker of carbon fibers that wants to know what kinds of materials are best suited for the next generation of manufacturing processes. BMW has about a dozen of the department's Ph.D. students on its payroll; their dissertation projects are part of preproduction research for the i3. Equipment makers such as KUKA (robots) and Manz (composites presses) are deeply integrated into the university's research as well.

Multiply this intense networking by dozens of universities specializing in technology and engineering. At RWTH Aachen University, more than 20 university institutes focus on state-of-the-art production techniques, cooperating with machinery makers, robot companies and software developers to make manufacturing processes so efficient that a high-wage country such as Germany can compete with the likes of China. RWTH Aachen is now building a $2.5-billion industrial park for companies partnering in this research. The Karlsruhe Institute of Technology specializes in nanotechnology and materials science, working with Germany's leading chemicals companies, such as BASF, to design new substances that will allow batteries to store renewable energy more efficiently and cheaply. At the Technical University of Dresden, researchers partnering with chipmakers and infotech companies are developing integrated circuits that use one hundredth the energy of current-generation electronics.

The German government, too, plays a crucial role. Whereas the country funds excellent labs for basic science, such as the Max Planck network of 80 institutes covering disciplines as disparate as particle physics and evolutionary biology, Germany's most economically successful research institution is the Fraunhofer So-ciety. Its network of 60 technology centers is cofinanced by the government and businesses and thus is strictly market-driven. Fraunhofer's $2.5-billion annual budget is also flush with patent income, most notably from its invention of the MP3 data format in the 1980s.

A unique trust

Closely partnering with nearby universities, each Fraunhofer center acts as a transmission belt to an entire cluster of companies networked with the center—and with one another—through collaborative research designed to find its way into processes and products. There are centers for every conceivable industrial sector, including polymer research for chemical companies, precision optics for the makers of sensors and lasers, and nanoelectronics to produce next-generation IT components.

Several centers, such as the Fraunhofer Institute for Production Technology in Aachen, focus on developing cost-efficient manufacturing techniques to keep Germany competitive with China. And for composites research, there is a Fraunhofer project group in Augsburg near Munich that grew out of a cold war–era rocket propulsion lab. Partnering with TUM and more than 50 companies, including BMW, Audi and Airbus owner EADS, the Augsburg center is already working toward the next generation of composite fibers derived not from petroleum but from lignin, an inexhaustible by-product of the wood and paper industries.

What also speeds up the transmission of these technologies is the encouragement of job-hopping of researchers and engineers. The average Fraunhofer scientist, for example, switches to an industrial company after five to 10 years, and many of the best corporate engineers also do stints as professors or Fraunhofer directors. Klaus Drechsler, professor and head of the Institute for Carbon Composites at TUM, spent part of his career at EADS developing composites for the Airbus. Now he is in charge of setting up the new Fraunhofer center for composites in Augsburg. This kind of job-hopping, crucial in diffusing expertise and technology, is much rarer in the U.S., where a government researcher usually stays in one place for life.

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This intense and complex collaboration is typical of German innovation. Much of it grew over decades among companies large and small that are now so used to working together they know instinctively what information they can share and what is best kept proprietary. “This trust between companies and institutions that cooperate but also compete is unique—you don't see that in very many countries,” says Beñat Bilbao, an economist at the World Economic Forum in Geneva and co-author of the latest “Global Competitiveness Report,” which every year shows Germany outranking the U.S. in industrial innovation. Most of these clusters of companies and their suppliers grew organically over decades (in some cases over centuries, such as the former clockmakers in the Black Forest that are now the world's leading producers of precision surgical instruments), which makes them not so easy to copy.

Still, the Germans manage to keep creating such networks in newly emerging industries. One of the latest is the BioEconomy Cluster near Leipzig, where a network of more than 60 companies and research institutes is developing ways to produce chemicals and plastics from biomass, replacing costly and CO2-spewing petroleum not just for energy but for other products now refined from oil. When Fraunhofer sets up new tech centers, it identifies companies and institutions that are already strong in their fields instead of trying to create something from scratch. “Our philosophy is to take something that's already working and water it so that it grows,” says Fraunhofer Society president Hans-Jörg Bullinger. In setting up the new carbon composites cluster, for example, Fraunhofer identified existing companies and university departments and provided funding, staff and a facility to encourage collaborative research.

The second lesson, Bullinger says, is to commit to the long haul. New Fraunhofer centers have their funding secured indefinitely and are left to themselves, with no evaluation taking place for the first five years beyond the requirement that they raise double their seed money from private companies. The companies, too, are invested for the long term; many of Germany's most innovative and tech-driven manufacturers are family-owned companies that do not worry about quarterly reports. A typical German tech company looks like Trumpf, an almost invisible, family-owned firm that has been a world leader in industrial laser technology for over a generation and now has annual sales of almost $3 billion. Fraunhofer, too, added 3,000 new researchers in the worst phase of the financial crisis. “Many countries have tried to copy us,” Bullinger says. “But their efforts fail because they think short term.”

That may be the fatal flaw in President Barack Obama's proposal, unveiled in March, for a $1-billion National Network for Manufacturing Innovation that is explicitly modeled after Germany's Fraunhofer. If Congress approves it, the network will be a public-private partnership in cooperation with manufacturing companies to put in place up to 15 manufacturing technology centers around the country—so far so good. But the funding is only set up for the first four years. In Bullinger's view, that is much too short for the best companies and researchers to commit to serious projects. “The likely result is a scramble for project money instead of something sustainable,” Bullinger says. Still, he says, it is a step in the right direction.

The German system has its weak sides, of course. The country's precision culture can be better at perfecting existing technologies than inspiring radical innovation. And the nation has had its periods of “technophobia,” during which politicians and protest movements chase away promising high-tech industries, such as biotech in the 1980s. But Germany's drive for industrial innovation has put to rest the old cliché that manufacturing is low tech and has set an example of how to go head-to-head with China. Those graduate students reinventing manufacturing in a university lab in Munich are a model to learn from.