The German Economy and
U.S.-German Economic Relations
Raymond J. Ahearn
Specialist in International Trade and Finance
Paul Belkin
Analyst in European Affairs
November 30, 2009
Congressional Research Service
7-5700
www.crs.gov
R40961
CRS Report for Congress
P
repared for Members and Committees of Congress
The German Economy and U.S.-German Economic Relations
Summary
Germany is the world’s fifth largest economy and the largest in Europe, accounting for about one-
fifth of the European Union’s (EU) GDP. Germany is also the largest European trade and
investment partner of the United States. Mutually profitable and growing U.S.-German
commercial ties historically have been facilitated by a strong German economy. The health and
functioning of the German economy, as well as its approaches to international economic policy
issues, thus, are of considerable importance to the United States as well as to the rest of Europe.
By most standards, post-war West Germany registered impressive economic performance in the
first decades of its existence. But beginning in the mid-1990s, the German economy has been on a
much lower growth path, averaging about 1.5% of GDP per year. Unemployment has also risen
steadily. These trends, which are expected to be exacerbated by a steep decline in German GDP
growth in 2009, raise questions about the long-term vitality and strength of the German economy.
A number of factors help explain Germany’s declining growth rate. One factor has been the high
cost associated with integrating the formerly communist East German economy into the Federal
Republic since reunification in 1990. A second has been the growing cost of Germany’s generous
social security and welfare programs and associated regulations which some believe may
undercut incentives for work and entrepreneurship. A third is an economy that is more geared
towards exporting than domestic investment and consumption.
With few exceptions, German governments have generally been reluctant to advance what many
economists consider necessary but unpopular economic policy reforms, including cut-backs in
welfare programs and labor market protections. Some believe that Chancellor Angela Merkel’s
September 2009 reelection in coalition with the pro-business Free Democratic Party (FDP) could
increase the likelihood of market-friendly reforms being enacted, but any radical restructuring of
Germany’s social market economy is considered unlikely.
With declining economic growth and rising expenditures on social protections, Germany faces
significant budgetary and resource constraints. This resource crunch could limit Germany’s
flexibility in pursuing domestic and international policy goals, arguably making Germany less
capable of compromise on matters of potential economic advantage. In this regard, Germany’s
domestic economic challenges could limit its policymaking flexibility. This has affected not only
the economic and trade leadership role Germany has traditionally played in Europe, but also its
position on issues that directly affect U.S. interests such as the global economic downturn and
economic sanctions.
A prosperous German state remains critical to both the U.S. and European economies. Difficulties
Germany may have in regaining a stronger economic position are important concerns, affecting
the U.S.-German partnership’s ability to mutually address and manage a range of bilateral,
regional, and global challenges. This report elaborates on these themes in three parts: the first
section examines Germany’s economic performance in historical perspective and assesses some
of the domestic factors that may be contributing to Germany’s less than optimal performance; the
second discusses the reform challenges facing Germany’s political leaders; and the third section
evaluates a few salient U.S.-German economic policy differences and strains that seem to be
influenced by Germany’s weakened economic situation.
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The German Economy and U.S.-German Economic Relations
Contents
Overview .................................................................................................................................... 1
Germany’s Economic Performance: Factors Explaining Declining Growth.................................. 4
The Costs of Reunification.................................................................................................... 6
Social Welfare Costs ............................................................................................................. 9
Export Dependency Costs ................................................................................................... 10
Reform Efforts and Political Challenges .................................................................................... 14
Past Efforts ......................................................................................................................... 15
Future Challenges and Prospects for Reform ....................................................................... 16
U.S.–German Economic Policy Strains and Differences ............................................................ 18
Trade Leadership ................................................................................................................ 18
Responding to the Global Economic Downturn ................................................................... 19
Economic Sanctions ............................................................................................................ 21
Figures
Figure 1. Germany’s Public Debt as % of GDP............................................................................ 8
Figure 2. Germany: Fixed Investment as % of GDP................................................................... 13
Tables
Table 1. Germany: Annual GDP Growth Rates for Selected Years............................................... 5
Table 2. Germany: Unemployment Rate, 2000-2010.................................................................... 5
Table 3. Germany’s Current Account Position ........................................................................... 13
Table 4. Germany: Net Direct Investment Flows ($ billions)...................................................... 14
Contacts
Author Contact Information ...................................................................................................... 23
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The German Economy and U.S.-German Economic Relations
Overview
With a population of 82 million and a GDP of $3.6 trillion, Germany is the world’s fifth largest
economy (after the United States, China, Japan, and India) and the largest in Europe, accounting
for about one-fifth of the gross domestic production (GDP) of the European Union (EU).1 Based
on a per capita income of around $44,280 (2008), Germany is one of the world’s high-income
countries. Germany has also been the world’s number one exporter of goods and the largest
European trade and investment partner of the United States. Although its economic and
commercial policies are increasingly determined within the EU, Germany plays a key role in
influencing EU policies. The health and functioning of the German economy, as well as policy
approaches adopted by the government, are not only of bilateral and regional importance, but also
of global importance to the United States.
Since its founding in 1949, the Federal Republic of Germany has experienced a continuous rise in
living standards.2 GDP per person has risen by a factor of 6 since 1950. This increase in material
well-being has helped create a very stable middle class. German firms remain competitive
internationally and the work force tends to be highly skilled. The economy is heavily dependent
on exports. In 2008 exports of goods and services accounted for 47% of Germany’s GDP—more
than three times the rate in the United States. Germany’s strong export performance in goods or
merchandise is also denoted by the term Exportweltmeister (world champion exporter). At the
same time, relatively weak consumer demand is a consistent feature of the German economy.
Germany has been a driving force in European integration, including the creation of the European
Monetary Union. Germany’s EU partners remain its prime trade customers and suppliers. In
2008, 63% of German exports went to other EU member states and 64% of its imports came from
other EU member states.3 The United States is Germany’s largest trading partner outside of
Europe. In 2008, 7.2% of German exports went to the United States and 4.2% of its imports came
from the United States. In turn, Germany is the United States’ largest European trading partner
and its fifth largest trading partner worldwide, accounting for 4.5% of U.S. total trade.4
The two countries also share strong foreign direct investment (FDI) ties. The United States in
2008 accounted for $110 billion, or over 25%, of Germany’s total stock of outward FDI and was
the second most important provider of FDI in Germany. Germany’s stock of FDI in the United
States stood at $212 billion in 2008, making Germany the fifth largest foreign investor in the
United States.5
These investments drive trade and create jobs. In 2007, 62% of U.S. imports from Germany
consisted of related party trade—trade between German parent companies and their own affiliates
in America. German companies doing business in the United States employ about 670,000
people, or one in every 200 people in the private sector. U.S. companies operating in Germany
1 Country GDP rankings based on purchasing power parity measure. CIA, The World Factbook, 2008.
2 Between 1949 and 1990, two German states, the western-oriented Federal Republic of Germany, or West Germany,
and the communist German Democratic Republic, or East Germany, existed side-by-side. The East German regime
collapsed between 1989 and 1990 and East Germany ceased to exist after German reunification on October 3, 1990.
3 IMF, Directions of Trade, 2008.
4 U.S. Census Bureau, Foreign Trade Statistics.
5 Survey of Current Business, Direct Investment Position for 2008, July 2009.
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employ nearly 800,000 people, which accounts for nearly one out of every 35 jobs in the private
sector.6
Mutually profitable, growing, and beneficial U.S.-German commercial ties historically have been
facilitated by a strong German economy. By most standards, West Germany registered an
impressive economic performance in the 1950s and 1960s, the first decades of its existence.
Powered by export-led economic growth based on low wages and high-level engineering, the
Federal Republic of Germany grew at an average of 6.3% per year during this twenty-year period.
The economy grew at a less rapid, but still strong pace of 3.6% per year in the 1970s and 1980s.
But beginning in the mid-1990s, the German economy has been on a much lower growth path,
averaging around 1.5% GDP growth per year (as compared to an OECD average growth rate of
2.7%). Unemployment has ratcheted upward since 1970, from virtually full employment to a
situation where in some years 10% of the population is out of work and another 4% can’t find
work but are in government programs. These trends, which are expected to be exacerbated by a
4.8% to 6% decline in German GDP growth this year, raise questions about the long-term vitality
and strength of this European powerhouse.7
A number of mostly domestic factors may account for Germany’s suboptimal economic
performance. These include the heavy and continuing costs of reunification with East Germany in
1990, escalating costs associated with generous social security and welfare programs, rigid labor
market laws and perceived over-regulation, and an economy more geared towards exporting than
consumption. Amidst the current global economic slowdown, questions have been raised
concerning the impact that Germany’s export dependency has on the domestic economy,
particularly for growth.
Some of the aforementioned factors are at the same time valued by many Germans as essential
features of the country’s so-called social-market economy. Since the founding of the Federal
Republic and reunification in 1990, German policymakers have consistently pursued parallel
national goals of export-driven economic growth and social cohesion through a robust system of
social welfare programs. Most Germans appear to continue to take pride in Germany’s position as
a leading exporter and to support government-funded programs aimed at reducing economic
disparities within their society. In turn, German political leaders have displayed a willingness to
sacrifice a degree of economic growth for what they perceive as social cohesion.
These preferences are evident in the reluctance of most German governments to pursue the kinds
of economic reforms advocated by many economists. Most recently, from 2005-2009, a so-called
grand coalition government of the center-right Christian Democratic/Christian Social Union
(CDU/CSU) and the left-of-center Social Democratic Party (SPD) proved reluctant to advance
unpopular cut-backs in welfare programs and labor market protections. Some believe that
Chancellor Angela Merkel’s (CDU) September 2009 reelection in coalition with the pro-business
Free Democratic Party (FDP) could increase the likelihood of market-friendly reforms being
enacted, but any radical restructuring of Germany’s social market economy is considered
6 U.S. Embassy Berlin, The German-American Partnership: Benchmarking Success, November 2008.
7 The extent of Germany’s economic contraction in 2009 remains unclear. In March 2009, the German government
revised earlier economic forecasts for 2009 to predict a 6% contraction in GDP growth for the year (it had announced
an expected 2.5% decline in January). Based on an unexpected 0.3% boost in GDP growth in the second quarter of the
year, the Economist Intelligence Unit has softened earlier predictions and expects a 4.8% contraction in GDP growth
for 2009. Aggregate GDP growth in the EU’s 27 member states is expected to contract 4.2% in 2009. See Economist
Intelligence Unit, Country Report: Germany, November 2009.
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unlikely. Failure to enact substantial reforms could mean that the problems posed by an aging
population and Germany’s system of social benefits will place an even larger strain on the
economy in the future.
Germany’s Political Parties: Overview and Key Economic Policy Positions
The Christian Democratic Party and Christian Social Union (CDU/CSU). Founded by West Germany’s first
post-war Chancellor, Konrad Adenauer, the CDU runs in federal elections with its Bavarian sister party, the CSU.
The parties jointly pursue a center-right policy platform, with the CDU generally more conservative on economic
issues than the CSU and the CSU more conservative on social values associated with the Catholic church. During the
previous government (2005-2009), Merkel was criticized by some within her party and by members of the FDP (see
below) for being too reluctant to pursue free-market reforms such as a further liberalization of the labor market and
reducing the tax burden on employers. In the face of the economic downturn, Merkel and her partners in the CSU
have been cautious about pursuing such reforms and have emphasized the need to provide support to the poor and
unemployed as wel as to the business community.
The Social Democratic Party (SPD). Germany’s oldest political party, the SPD has evolved from a socialist party to
a social democratic party, but continues to see itself as the representative of the German working class and enjoys
close ties to Germany’s trade unions. Now in opposition for the first time since 1998, the party has been chal enged
to overcome internal divisions between its more centrist wing represented by some of the party’s veteran
policymakers and a left wing of younger lawmakers. The internal debate within the SPD has been exacerbated by the
emergence of the Left Party, which has sought to distinguish itself as a left-wing alternative to the SPD. Under former
Chancel or Schröder, the SPD championed stringent economic reforms that were opposed by most Germans and
some of the party’s base. In opposition, the party appears poised to oppose economic policies it perceives as too
“pro-business” such as tax cuts for employers, and to seek to strengthen protections for German workers and the
poor and unemployed.
The Free Democratic Party (FDP). The junior coalition party in the current government, the FDP considers itself a
liberal party, advocating individual freedom and limited government involvement in economic and social issues. Since
its inception in 1948, the party has governed in coalition with both the CDU/CSU and SPD, but is considered a more
natural al y of the CDU. While in opposition from 1998 to 2009, the FDP distinguished itself by advocating free-
market, pro-business policies and the protection of individual civil liberties. The FDP favors extensive tax cuts and a
reform of Germany’s social welfare structure, including its public health system. Some commentators speculate that a
return to government could soften the FDP’s cal s for stronger reforms. Party leader Guido Westerwel e is Vice
Chancellor and German Foreign Minister.
The Left (Die Linke). The Left Party was formed in 2007 as a merger of the Party of Democratic Socialism (PDS)—
the successor to East Germany’s ruling Socialist Union Party—and the Electoral Alternative for Labor and Social
Justice (WASG), based in western Germany. The most left-wing party in the German parliament espouses a platform
of social solidarity in the face of globalization. The party calls for redistribution of wealth through taxes on
corporations and the rich, a minimum wage, curbs on privatization, and more self-determination for workers. The
party enjoys strong support in eastern Germany and is considered a potential future coalition partner of the SPD.
Should the SPD and The Left overcome existing differences, the grouping could represent a leftward shift in German
politics.
Alliance ’90 / The Greens. Founded in 1980 as an opposition movement, the Green Party has become a widely
respected mainstay in German politics. The Greens have had continuous representation in the German parliament
since 1983 and were a junior coalition partner in the Schröder government from 1998 to 2005. The party has long-
advocated enhanced environmental protection and sustainable development and has promoted achieving economic
growth through such development. In the Schröder government, the Greens successfully pushed for a gasoline tax
which channeled revenues to spur clean energy development. Although the party is on the left of the political
spectrum, it has entered into coalition governments with the CDU at the regional level and is considered less
beholden to trade unions and more open to economic reform than the SPD.
As a result of its declining economic growth, aging population, and the growing costs of
maintaining generous social security programs, Germany, as many other industrialized countries,
faces a resource crunch. This resource crunch arguably has limited Germany’s flexibility to
maneuver domestically and appears to have been a factor in the evolution of somewhat more
assertive German international economic policies. With dwindling economic and financial
resources, Germany arguably has become less capable of compromising on matters of potential
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economic advantage. This has affected not only the trade and economic leadership role that
Germany has traditionally played in Europe and the world economy, but also its position on
issues that directly affect U.S. interests. These include different approaches in dealing with the
global economic downturn and economic sanctions.
In short, a prosperous German state remains critical to both the U.S. and European economies.
Difficulties Germany may have in regaining a stronger growth pattern are an important concern,
affecting the U.S.-German partnership in addressing a range of bilateral, regional, and multilateral
challenges.
This report elaborates on these themes in three parts: the first part examines Germany’s economic
performance in historical perspective and assesses some of the domestic factors that may be
contributing to Germany’s less than optimal growth pattern in recent years. The second section
discusses the reform challenges facing German political leaders. The third section evaluates
selected U.S.-German economic policy differences and strains that may be influenced by
Germany’s economic situation.
Germany’s Economic Performance:
Factors Explaining Declining Growth
In the first decades of its existence, West Germany experienced impressive economic
performance. Powered by export-led growth and close collaboration between business,
government, and labor, the Federal Republic of Germany was hailed as an “economic wonder”
(Wirtschaftswunder) as it averaged 8.2% growth rates during the 1950s, 4.4% in the 1960s, and
2.8% in the 1970s. In the 1980s, Germany’s economic performance began to slip further, falling
to an annual average increase of 2.3%. As shown in Table 1, with only a few years of exceptions,
the growth rate has continued to decline since 1990.8 In the 1990s, Germany recorded an average
growth rate of only 1.6% and a meager 0.6% between 2001 and 2005. The economy did bounce
back in the three years from 2006-2008, with growth averaging 2.3%. But the economy was again
hard hit in late 2008 and early 2009 by the global economic downturn. Germany’s economy is
expected to contract by 4.8% to 6% this year, compared with a 4.2% drop in the Euro-zone
overall.9
Once Europe’s growth engine, Germany since the mid-1990s has had, along with Italy, one of the
lowest growth rates in Europe. The aggregate output of the German economy, for example,
increased by 7% between 2000 and 2009 compared to a Euro Area increase of 12.6%.10
8 Growth rates over 4% were registered in 1990 and 1991, the boom years of reunification. The economy also grew at a
much more rapid pace in 2006-2008. This was thought to be due largely to rising export demand but also to economic
reforms implemented in 2003 and 2004.
9 See footnote 7.
10 OECD data.
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Table 1. Germany: Annual GDP Growth Rates for Selected Years
(in percent change)
1950-
1960-
1970-
1980-
1991-
2001-
1960
1970
1980
1990
2000
2005
2006 2007 2008 2009a
8.2 4.4 2.8 2.3 1.6 0.6 3.2 2.6 1.0 -6.0
a. Projected.
Source: German Federal Statistical Office, OECD.
Slower German economic growth, in turn, has been accompanied by high unemployment (see
Table 2). In the 1960s, both West and East Germany had almost no unemployment. In 1970,
about 150,000 people or 0.7% of the labor force were unemployed—compared to over 3 million
today. But by 2005 unemployment reached 11.7% nationwide and 18% in the states of the former
East Germany.11 When the economy did bounce back in the three years from 2006-2008, with
growth averaging 2.3%, unemployment also fell from nearly 5 million to around 3.3 million, but
the unemployment rate barely dipped below 8%. The OECD also predicts that the number of
unemployed will rise to 5.1 million and that the unemployment rate will increase sharply to
11.6% by the end of 2010.12
Table 2. Germany: Unemployment Rate, 2000-2010
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009a 2010a
9.6 9.4 9.8 10.5 10.6 11.7 10.8 9.0 7.8 10.1 11.6
a. Projected.
Source: EIU database, OECD World Economic Outlook, June 2009.
Many economists argue that unemployment in the German economy is higher than the
unemployment data indicate. This “hidden” unemployment is allegedly due to a large number of
workers employed in government schemes or subsidized in early-retirement programs. In
addition, the government funds a so-called “short-term working benefit” (Kürzarbeit) through
which it subsidizes 60%-67% of lost income for individuals whose working time has been
reduced by their employer. According to some estimates, the program has saved at least 400,000
jobs and 1.4 million employees are working shorter hours.13
High unemployment translates into underutilization of the German labor force and foregone
production. The fact that the German labor force, on average, tends to work fewer hours than its
counterparts in most industrialized countries, and enjoys more paid leave and holidays, could
further impede more robust economic growth.14 On the other hand, as noted above, many
Germans appear comfortable foregoing potential gains in economic growth in order to maintain
relatively generous social benefits.
11 Andreas Falke, “The Internationalisation of Germany: Adapting to Europeanisation and Globalisation,” In
Germany’s Gathering Crisis: The 2005 Federal Election and the Grand Coalition, eds. Alister Miskimmon, William E.
Paterson and James Sloan, Palgrave MacMillan, 2009.
12 OECD Economic Outlook, June 2009.
13 Judy Dempsey, “Merkel Says Worst Still Ahead in Germany,” New York Times, November 11, 2009.
14 Horst Seibert, The German Economy, Princeton University Press, 2005, p. 44.
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A number of factors help explain Germany’s declining growth record. One factor has been the
high costs of integrating the formerly communist East German economy into the Federal
Republic. A second factor is Germany’s generous social welfare provisions which may undercut
incentives for work and entrepreneurship. A third is an economy that may be excessively
dependent on exports, and saddled with labor market rigidities and other barriers that make
investment in the domestic economy less attractive than investing abroad. These trends are
discussed below.
The Costs of Reunification
With German reunification in 1990, West Germany realized what had been its single most
important national objective. Reunification also represented a major change in the country’s
economic condition. In practical terms, a relatively strong West German economy of about 63.2
million people took over a reeling economy of 16.1 million people which had been essentially
isolated from the West for over 40 years. For the former East Germany, this meant a drastically
new environment for its population. German policymakers set out to privatize state-owned firms,
production was to be reoriented towards the markets of the West, and new roads, housing, and
public infrastructure began to be constructed.15 The results of these policies have been at best
mixed and today, some estimate the total value of transfers from west to east since 1989 at
upwards of $2 trillion.
The West German economy was fairly strong when the reunification process began. Price
stability had been achieved, the government budget was balanced, and the country’s transactions
with the rest of the world (i.e., its current account) were in surplus by almost 5% of GDP. The
East German economy, on the other hand, had a per capita GDP just 40% of that of its western
neighbor.
In hindsight, some observers think that the strong economic situation in the west perhaps led the
government to underestimate the economic burden that reunification would entail and caused it to
commit a number of policy mistakes in the process. One oft-cited example is the decision to
exchange the East German currency at a one-to-one rate for the West German deutschmark. This
action effectively quadrupled East German wage costs in terms of deutschmarks. While the one-
to-one currency conversion raised East German wage costs to only 30 percent of the West
German level, subsequent increases may have undermined the attractiveness of East Germany for
investors.16
A second scrutinized policy decision was to extend West Germany’s social welfare system, with
its wage-replacement benefits in terms of early retirement, unemployment compensation, and
social assistance, to East Germany. These benefits arguably prevented wage rates from settling at
a level that would have made East German labor competitive, particularly given the lower level of
productivity of East German workers.17
Proponents of the one-to-one currency valuation and the decision to extend West Germany’s
social welfare system east argue that these moves were both inevitable and necessary given the
15 Ibid., p. 18.
16 Ibid., p.19.
17Hans-Werner Sinn, Can Germany Be Saved?, MIT Press, 2007, pp. 164-165.
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political context. One of the West German government’s primary goals with regard to
reunification was to avoid a mass migration of people from east to west and to ensure social and
economic cohesion between east and west. In explaining the rationale behind the one-to-one
currency valuation, then-West German Foreign Minister Hans-Dietrich Genscher has said, “If we
had not brought the deutschmark to the east, the east would have come to the deutschmark.”18
West German leaders believed that their best policy option was to extend the West German
currency and its social market economy east despite the potentially negative consequences for the
regional economy.
German reunification required, and still requires, large annual public transfers to the east,
estimated to be roughly 3%-4% of western Germany’s GDP and more than one-third of the
federal budget. This sum has placed a heavy burden on the economy of western Germany.19 It is
also estimated that only one-quarter of total transfers to the east are used for investment, either in
the private sector or for infrastructure. Most of the transfers are thought to go to public and
private consumption.20
The budgetary transfers were financed to a large extent by issuing bonds rather than by increasing
taxes, leading to a doubling of government debt. As shown in Figure 1, in the nearly twenty years
since reunification, total government debt as a percentage of gross domestic product has doubled,
rising from 39.4% in 1991 to a projected 83.8% in 2010. Debt service payments on this amount of
debt has equaled in recent years around 15% of total federal budget expenditures, or between
2.2% and 2.4% of GDP (as compared to the OECD average of between 1.7% and 1.8% of
GDP).21
18 Hans Dietrech Genscher, remarks at The German Marshall Fund event “Twenty Years After the Fall of the Berlin
Wall: A Europe Whole and Free?,” The Newseum, Washington, DC, November 2, 2009.
19 Ibid., pp. 148-149.
20 Horst Seibert, The German Economy, p. 42.
21 Wolfgang Streek, “Endgame? The Fiscal Crisis of the German State,” In Germany’s Gathering Crisis, p. 47.
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Figure 1. Germany’s Public Debt as % of GDP
Note: 2009 and 2010 figures are projections.
Source: EIU database.
The higher debt and interest rate burden has had an adverse impact on Germany’s fiscal policy
stance. Due to the rising interest payments on the new debt, the leeway for tax reductions has
been severely reduced. In the process, tax rates for German firms have remained higher than
those in other EU countries.22
Despite the magnitude of transfers from the west to the east, the challenge of bringing the
economy of the east up to the standards of the west persists. The eastern German economy still
depends upon resource transfers from western Germany for 45% of its total expenditures. While
eastern German aggregate income has almost reached the western German level, aggregate
productivity is only about 60% of the western German level. At the same time, in some areas of
eastern Germany per capita GDP is less than half that in western Germany. Some eastern areas
are also confronting population declines of 20%. Moreover, there are few indicators to suggest
that the eastern German economy, after nearly two decades since reunification, is close to
becoming self-sustaining. Continuing dependency on transfer payments could represent a heavy
burden on western German businesses and employees in the years ahead.23
22 Horst Seibert, The German Economy, pp. 21, 42.
23 Hans-Werner Sinn, Can Germany Be Saved?, pp. 148-151.
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Social Welfare Costs
After World War II, West Germany constructed the so-called “social-market economy” that
remains the foundation of the current German economic model.24 The basic idea was to create a
competitive economy safeguarded by social protections with minimal government intervention in
markets. At its core, the approach attempts to generate a more stable and equitable distribution of
income than the outcome which market forces alone would achieve. It does so through a range of
institutional arrangements that generally include market capitalism, strong protection of labor and
unions, a relatively large welfare state, and tight regulation of markets. Born out of the traumatic
experience of the economic and political chaos of the 1920s and 1930s, it was “an attempt to
harness free market capitalism while simultaneously avoiding the social problems created by
unfettered laissez-faire, on the one hand, and a centrally-planned economy, on the other.”25
German social programs consist of old age pension support, nursing or long-term care insurance,
health insurance, and unemployment insurance. These programs were greatly expanded in the
1970s to allow more citizens to share in the fruits of the then prospering West German economy.
Unemployment compensation and social assistance benefits were raised, working time was
reduced and early retirement options were created. The pension insurance system was expanded
to the self-employed and public university tuition fees were done away with.
Despite recent reforms that have limited the scope and duration of benefits, German welfare
programs remain quite generous compared to those provided by other industrialized countries.
Until 2004, unemployment compensation, for example, provided for replacement of more than
50% of a person’s previous net earnings and for an unlimited period of time.26 The old-age
pension system provided a retirement income worth nearly 70% of the net average wage before
retirement.27 Moreover, an estimated 40% of Germany’s adult population (pensioners, social-
welfare recipients, unemployed, accident victims, and students) receive some form of state
income transfer, with even higher percentages in eastern Germany.28
Most economists believe unemployment and welfare payments should aim to insure against
hardship caused by unemployment or other life changing events without undermining incentives
to work. Yet, there is evidence that some German programs have had an impact on incentives to
work by granting much of this assistance on condition of labor income not being earned. That is
to say that under some German programs, if labor income is earned, much of the assistance is cut.
The so-called “wage replacement” incomes provided by these programs, thus, can contribute to
unemployment by operating as wage floors. This is because people receiving state assistance
could be unwilling to take a job in the private sector at a wage that is not substantially higher than
the wage-replacement income provided for remaining unemployed.29
24 The social welfare system originated in Germany under Chancellor Bismarck in the late 19th century and then spread
to the rest of western Europe.
25 Stormy-Annika Mildner and Mark Prentice, “Germany’s Social Market Economy: Old Wine in Old Bottles?,” in
AICGS, Germany’s Founding Pillars at 60: Future Challenges and Choices, p. 9.
26 Hans-Werner Sinn, Can Germany Be Saved?, p. 108.
27 Horst Seibert, The German Economy, p.114.
28 Hans Werner Sinn, “The World Owes Germany Thanks,” May 3, 2009.
29 Hans-Werner Sinn, Can Germany Be Saved?, p. 107.
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Offering incentives not to work may put upward pressure on private sector wages and thereby
undercut the competitiveness of German workers. It may also saddle German businesses with
added costs because the bulk of the expenditures of the social welfare system are financed by
contributions paid half by employees and half by employers.30
The burden of taxes and social security contributions on German employees is high. Non-wage
labor costs, in the form of social security contributions (pension, unemployment, and health
insurance) have for years exceeded 40% of workers’ pay. Many economists maintain that cutting
these taxes on labor would be the most effective way to revive the labor market and reduce
unemployment, particularly among workers with low-skills.31
Germany’s population size has been declining since 2002. Against the backdrop of an aging
population, social welfare costs continue to escalate.32 Germany’s share of public social
expenditure in GDP today exceeds 30%.33 Combined with the increasing numbers of pension and
retirement claims forecast for the coming decades, the costs and job market consequences of the
social benefits system could limit the maneuvering space for fiscal policy in the future and could
continue to have adverse effects on incentives for work and entrepreneurship that many consider
critical for stimulating faster growth.34
Export Dependency Costs
Germany’s strong export performance has been a constant feature of the German economy since
the founding of the Federal Republic. A future Chancellor, Ludwig Erhard, set the tone for
German trade policy when he was minister for economics in 1953 by stating that “foreign trade is
not a specialized activity for a few who might engage in it, but it is the very core of our economic
and social order.” Subsequently, it has become common to speak of the German “export
mystique” and efforts to increase competitiveness. German diplomatic missions rarely make visits
abroad without including select businessmen in their official delegations.
Various data illustrate the growing role that exports have played in Germany’s economy. In 1950,
exports represented 9.3% of GDP. Once the postwar economic boom got under way, exports rose
to 17.2% of GDP in 1960. The rise continued to 23.8% in 1970, to 26.7% in 1980, and to 33% in
1990. By 2008, German exports were accounting for 47% of GDP, compared to less than 20% in
Japan and about 13% in the United States.35
Since 2004, Germany has been the world’s top exporter of merchandise or goods, surpassing the
United States, Japan, and China.36 The title of Exportweltmeister (export champion) is a source of
great pride for many Germans. The main German exports—cars, precision machinery and
30 Horst Seibert, The German Economy, p. 114.
31 Wolfgang Streek, “Endgame: The Fiscal Crisis of the German States,” p. 39.
32 Among industrialized countries, Germany is projected to have the second largest percentage (22.7%) of its
population over 65 by 2020. OECD data.
33 Hans-Werner Sinn, Can Germany Be Saved?, p. 24.
34 Horst Seibert, The German Economy, p. 261.
35 EIU Data Base.
36 In 2007, the most recent year where data are available, Germany accounted for 9.7% of world merchandise exports,
followed by China (8.9%), the United States (8.5%) and Japan (5.2%). Press reports have indicated that China overtook
Germany in 2008 as the world’s top exporter of goods. Source: WTO Statistics.
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chemicals—have come to symbolize a German identity based on skill, quality, and reliability.37 In
addition, many German small and medium-sized companies have also demonstrated exporting
prowess in niche markets, including beverage-filling equipment, vacuum technology, surgical
instruments, and binoculars and telescopic sights.38
What impact Germany’s exporting success has had on its overall economy over the past 10 to 15
years, however, is a matter of debate. One view is that Germany’s exporting success has not been
as positive for addressing core economic problems such as production and employment. Under
this view, Germany has maintained its lead in exports by systematically outsourcing and off-
shoring the labor-intensive parts of production to low-wage countries, primarily in Eastern
Europe. Consequently, the import content of German exports has increased dramatically over the
last several decades from 15% to 40%. Thus, the increase in exports cannot automatically be
equated anymore with a commensurate increase in domestic production and employment.39
A second view is that Germany has maintained its export competitiveness by pursuing a policy of
systematic wage deflation, thereby reducing unit labor costs. From 2001 until today, Germany
kept a tight lid on wages and, as a result, wages are still at almost the same level today as they
were eight years ago.40 In this way, Germany was able to raise its share of internal EU exports
substantially, mostly at the expense of its EU neighbors who did not exercise similar wage
restraint.41 This bottom-up process of sustained wage moderation and unit cost reduction was
reinforced by corporate-led changes to working conditions and time. According to one economist,
“this move lowered labor costs for exporting firms while it made imports more expensive, further
improving German price competitiveness relative to its European partners.”42
German wage discipline may also have tilted demand in favor of exports and away from
consumption. Even as exports boomed and jobs have been created, sluggish wages mean that the
gains from national income growth go mostly to profits. In the process, consumer spending has
suffered, falling to a low of 56% of GDP—well below the 65% of GDP level experienced in most
western economies. The increase in the rate of the value-added tax (VAT), from 16% to 19% in
early 2007 may have resulted in a further check on consumption.43
Observers raised concerns about Germany’s export dependency in 2008 and in early 2009 in the
face of the global economic slowdown. With the collapse of foreign demand, German exports are
expected to decline in 2009 by over 20%, making Germany’s deep recession export-led. Exports
of cars, machinery, and chemicals can provide a narrow and potentially vulnerable base for
prosperity in an integrated world economy.
To keep consumption from dropping even further, the previous grand-coalition government
implemented a range of policies intended to stimulate domestic economic growth and to support
37 Andreas Falke, “The Internationalisation of Germany,” p. 208.
38 Hans-Werner Sinn, Can Germany Be Saved?, pp. 33-34.
39 Andreas Falke, “The Internationalisation of Germany,” p. 208.
40 Yet, German manufacturing wages remain among some the highest in the world. Simon Taylor, “Rebalancing A
Disrupted Economy,” European Voice, May 7, 2009.
41This is often referred to as a beggar-thy-neighbor or protectionist policy.
42 Sebastian Dullien, “After the Election, Germany Will Continue to Obstruct Global Economic Rebalancing,” AICGS
Transatlantic Perspectives, June 2009.
43 The Economist, “Germany’s Economy: The Export Model Sputters,” May 9, 2009.
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the German private sector. In December 2008 and January 2009, the parliament passed domestic
stimulus measures totaling EUR 71 billion (about $100 billion) for 2009 and 2010. The so-called
“short-term working benefit” (Kürzarbeit) through which the government subsidizes individuals
whose working time has been reduced was expanded and the government also subsidized the sale
of new cars through a “cash for clunkers” program. German economists and officials also
emphasize the positive effects on domestic demand of so-called “automatic stabilizers,” public
expenditures for guaranteed social welfare benefits such as unemployment programs.
The German economy has shown some signs of picking up since the second quarter of 2009.
Many observers see this as evidence that the German export-led growth model is indeed
sustainable.44 These proponents, contrary to G-20 pledges to correct current account imbalances,
also tend to argue that other countries could benefit by reducing domestic consumption,
increasing savings and by implication, running a current account surplus, as Germany does. As
shown in Table 3, Germany has been running current account surpluses for the past decade.
Some economists counter that a large economy cannot run on “export fuel” alone and that
German policymakers should look for ways to make the economy more balanced by encouraging
consumption at home. This, in turn, would require Germans to spend and invest more at home,
thereby running smaller current account trade surpluses. They argue that for a sustained recovery
of the world economy to occur, trade surplus countries like Germany will have to run smaller
surpluses to accommodate the smaller current account deficits that countries like the United
States will have to experience by exporting more to the rest of the world.45
From an economic perspective, Germany’s large and enduring current account surpluses reflect a
persistent excess of domestic savings over domestic investment. While Germany’s gross national
savings has increased from an average of about 21% of GDP from 1990 thru 2003 to an average
of 24% of GDP between 2004 and 2008, its gross fixed investment share in GDP, as shown in
Figure 2, has declined from 21.5% in 2000 to 17.4% of GDP in 2005 before increasing to 18.4%
of GDP in 2008.
44 Simon Tilford, “Germany will not drive a European recovery,” Financial Times, August 31, 2009.
45 See, for example, Roland Berger, “How is Germany doing? Insights by Roland Berger,” Roland Berger Strategy
Consultants, October 22, 2009.
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Figure 2. Germany: Fixed Investment as % of GDP
Note: 2009 and 2010 figures are projections.
Source: EIU database, OECD.
Germany’s declining investment rate can also be viewed as the mirror image of net direct
investment flows. As shown in Table 4, Germany has experienced rising direct investment
outflows over the last decade. The largest net outflows of $125 billion in 2007 and $133 billion in
2008 occurred in the years of Germany’s largest current account surpluses.
Table 3. Germany’s Current Account Position
Year
Current Account Balance
Current Account Balance
($ billions)
as % of GDP
1995 -29.6 -1.2
1996 -16.8 -0.6
1997 -10.2 -0.1
1998 -17.1 -0.8
1999 -28.0 -1.3
2000 -33.9 -1.2
2001 0.3
0.0
2002 41.4
2.0
2003 47.9
1.9
2004 126.8
4.6
2005 142.2
5.1
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Year
Current Account Balance
Current Account Balance
($ billions)
as % of GDP
2006 190.1
6.5
2007 265.9
8.0
2008 243.4
6.6
2009a 90.3
2.8
2010a 100.0
3.0
Source: OECD.
a. Projected.
Table 4. Germany: Net Direct Investment Flows ($ billions)
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
150 -13 34 26 -30 -30 -70 -125 -133 -6 -36
Source: EIU Country Database.
In the view of some economists, Germany’s declining investment rate and net capital exports are
driven by domestic barriers or rigidities in the markets for labor and products. Among the most
notable barriers or rigidities often cited are the wage replacement policies that serve to maintain a
narrow gap between the best- and worst-paid employees. These policies may limit the earnings of
the most skilled workers across all sectors, tempting many to find work abroad, and could be
stunting the emergence of a low-wage service sector that could cater to the home market. If the
wage replacement policies tend to prop up the pay of unskilled workers, services become more
expensive and difficult to supply, thereby contributing to the pool of domestic savings going
abroad.46
Other indications of rigidities that affect decisions to invest in Germany include barriers to
starting a new business. Permits for building new facilities, limited shop hours, and regulations on
new products tend to stifle competition and deter new investments. According to the World
Bank’s 2009 Doing Business Survey, Germany ranked 102nd out of 181 countries on these and
other criterion.
Reform Efforts and Political Challenges
As illustrated in the first section of this report, the economic challenges facing German
policymakers include low economic growth, high unemployment, and a deterioration of public
finances. Also as shown, these problems are linked to the continuing costs of reunification, rising
social welfare costs, and the dependency on export-led growth. Moreover, troubling demographic
trends—Germany’s population has been shrinking since the 1970s and its birthrate is one of
Europe’s lowest—are further exacerbating the strain on the social market economy.
46 The Economist, “Rebalancing the World Economy: Germany,” August 8, 2009.
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German policymakers, politicians, and scholars have proposed or considered a number of reforms
aimed at reinvigorating and strengthening the German economy. These include changes in social
and labor policies that provide protections at the expense of a more efficient and dynamic
economy, as well as reforms that would create an economy driven more by domestic demand than
exports. Given the significant proportion of the German public that directly benefits from the
status quo, political opposition to reforms has been and continues to be significant.
Past Efforts
Successive German governments have recognized the importance of reforming the German
economy to bring about increased economic growth. However, all have found it difficult to sell
tough reforms to voters and vested interests. The most notable reform efforts since reunification
were undertaken in 2003 and 2004 by the left leaning coalition government of the Social
Democratic Party (SPD) and the Green party, under the leadership of then-Chancellor Gerhard
Schröder (SPD). Schröder’s far-reaching reform program, known as Agenda 2010, aimed at
boosting growth and employment and consolidating public finances through tax reforms, greater
labor market flexibility, and limited cuts in state benefits and subsidies.
The cornerstone and most controversial aspects of Agenda 2010 were a series of labor market
reforms, including the so-called Hartz IV reform, which sought to merge unemployment and
welfare benefits.47 One of the most publicized of these initiatives shortened the period for which
unemployment compensation could be received by most people from 32 months to 12 months.
The Hartz IV law abolished an existing program under which the long-term unemployed would
receive up to 57% of their last regular net income and replaced it with less generous social
assistance benefits already available to poor individuals, regardless of employment history. These
changes were publically justified by the need to pare back government expenditures, but it was
also hoped that the reforms would lower real wages and help create new jobs.48
Most experts agree that the Agenda 2010 reforms likely played a role in boosting GDP growth
and reducing unemployment in 2006 and 2007. However, at the time of implementation, the
reform program was broadly unpopular, caused deep rifts within the SPD, and arguably cost
Schröder the Chancellorship. Once the reforms were implemented, political support for the SPD
plummeted below 30 percent and he was forced to resign as chairman of the party. With his
eroding mandate, Schröder was compelled to call an early election in 2005, which the SPD lost.
Many observers believe the fall-out from Agenda 2010 also greatly affected the electoral outcome
in 2005. The SPD remained in the governing coalition, but as a junior party to its long-time rival,
Merkel’s center right Christian Democratic Party (CDU).
Both Merkel and the SPD appear to have taken a lesson from Schröder’s electoral defeat.
Although Merkel campaigned in 2005 as a reformer promising to liberalize restrictions on
business and to unburden taxpayers, as head of a grand coalition government with the SPD, she
adopted a cautious and modest approach to economic reform.49 Merkel and her supporters argue
that more ambitious reforms were not possible, given the coalition’s reliance on the left-leaning
47 The so-called “Hartz reforms” were based on proposals made by a government-appointed committee of 15 experts
chaired by Peter Hartz, then personnel director at Volkswagen.
48Hans-Werner Sinn, Can Germany Be Saved?, p. 108.
49 Alister Miskimmon and Walter E. Paterson, “Conclusion: coping with the Gathering Crisis,” In Germany’s
Gathering Crisis, pp. 222-223.
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SPD. However, others argue that Merkel was wary of championing unpopular reforms of the
welfare system, regardless of her coalition partner. Ultimately, the CDU/CSU-SPD grand
coalition government passed just one significant reform in the spirit of Agenda 2010, a gradual
rise in the retirement age to 67. More often, with Merkel’s help, the government rolled back
reforms by lengthening the time for paying unemployment benefits to older workers, offering
pensioners relief from rising prices, and introducing minimum wages in half a dozen industries,
including postal and security services.50
Future Challenges and Prospects for Reform
Germany’s reform challenges at the broadest level include efforts to redesign the welfare state
and encourage the development of a more balanced economy. Less equity and a lower level of
worker protection may be needed if a higher growth path and a higher rate of employment are to
be achieved. Given that Germany’s population is expected to decline by 3.5 million by 2020, with
a steady rise in individuals over the age of 65, the earlier the necessary adjustments are made, the
more effective they may be.
Assuming that expenditures on social security programs need to be reduced, benefits may have to
be redefined. This could entail a variety of changes such as increasing the retirement age or
eliminating social security coverage for many small risks or conditions. Other reform suggestions
to make German workers more competitive include working longer hours, substituting wage
supplements for wage replacements, and shortening the period of university education before
students enter the workforce.51 To deal with distortions in the labor market, changes in
governance have been proposed. Most of the proposals involve more decentralized ways of
determining wages and job security in the marketplace.52
To deal with Germany’s dependency on export-led growth, some experts believe that Germany
must try to develop a more balanced economy by promoting service industries such as health care
and education through tax policy and de-regulation. Yet, current political and business leaders
appear united in the belief that exports must remain the foundation of German prosperity. This
strategy hinges on the hope that world demand for German exports will eventually reinvigorate
the German economy.53 Indeed, some proponents of the German economic model challenge the
notion that the economy is in need of sweeping structural reform. They point out that economists
have been urging such reforms for decades during which time the economy has consistently
proven its resilience and continued to sustain itself. Furthermore, the value most Germans place
on the state’s long-standing social welfare programs suggests that they may be willing to forgo a
level of GDP growth in exchange for the increased social cohesion presumed to be brought about
by such programs.
Despite a general consensus among economists that structural reforms to the German economy
may be necessary to boost long-term economic growth, the short- to medium-term prospects for
such reform appear slim. German politicians have been reluctant to advocate unpopular limits on
social welfare spending at a time of economic contraction and increased unemployment. This
50 Economist, June 27, 2009.
51Horst Seibert, The German Economy, pp. 165, 369.
52 Ibid., p. 375.
53 Wolfgang Munchau, “Down and Out for the Long-term in Germany,” Financial Times, June 8, 2009.
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reluctance was evident in the 2009 election campaign, during which there was very little debate
over German economic policy and the need to revamp the German social welfare system or to de-
regulate the economy. Nor was there much debate about the need to stimulate domestic demand
or nurture the growth of services. 54 Whether Merkel’s newly elected center-right government will
change this calculation remains to be seen. However, early signs suggest that an immediate need
to stabilize a fragile economy, reduce record budget deficits, and cope with rising unemployment
could take precedence over efforts to launch deeper structural reforms. 55
The 2009 Election: Emerging fragmentation of the German political system?
Since 1949, Germany’s political landscape has been dominated by the country’s two largest political parties,
Chancellor Merkel’s center-right Christian Democratic Party/Christian Social Union (CDU/CSU) and the left-of-
center Social Democratic Party (SPD). One of these parties has been at the helm of every post-war German
government. The CDU/CSU and SPD have, however, slowly ceded support to smal er political parties on both sides
of the political spectrum—a fact illuminated by the 2009 election. Although Merkel’s CDU/CSU won 33.8% of the
vote, the most of any party, the CDU/CSU’s total was 1.4 percentage points less than in 2005. More significantly, the
SPD won only 23% of the popular vote, 11.2 percentage points less than in 2005.
The drop in electoral support for the CDU/CSU and SPD contrasted with gains for three smal er parties. The center-
right, free market-oriented Free Democratic Party (FDP) and the far-left Left Party (Die Linke) each achieved their
best ever electoral results, winning 14.6% and 11.9% of the vote, respectively; the Green Party won 10.7% of the
vote.
Merkel and the CDU/CSU formed a government in coalition with their preferred and traditional coalition partner, the
FDP. Nonetheless, observers believe the growing popularity of the FDP and the Green Party, and the emergence of
The Left Party, a successor of East Germany’s communist party, could signal an emerging fragmentation of the
German political system.
In particular, the ascendency of the populist Left Party appears to be putting pressure on the SPD to redefine itself,
either as a center-left or more left wing party. The degree to which the FDP will influence the policies of the new
government remains to be seen, but differences between the CDU/CSU and FDP, particularly on economic policy,
have emerged. According to some analysts, this political realignment could potentially undermine German policy and
leadership on a host of international issues, thereby making it more difficult for the United States and other countries
to work with Germany on resolving mutual challenges.56
A number of factors may account for the decline in popular support for the CDU/CSU and SPD, including public
dissatisfaction with the grand coalition government of 2005-2009, during which the traditional rivals governed together
in an arrangement some might compare to a U.S. Administration run jointly by Democrats and Republicans.
In her first address to the German parliament since being re-elected in September 2009,
Chancellor Merkel bluntly stated that she expects the German economy to face increasing
challenges in the coming year, including higher unemployment. She said her government’s
primary goal in addressing this challenge is to spur economic growth: “without growth, no
investment; without growth, no jobs; without growth, no money for education; without growth,
no support for the weak.”57 The government’s prescription for such growth appears to be a mix of
tax cuts, continued government spending to keep unemployment down, and a longer-term effort
to rein-in such spending. The Merkel government has extended the Kürzarbeit program by which
54 Carter Dougherty, “Debate on Economy Muted As Germany Prepares To Vote,” New York Times, September 25,
2009.
55 The Economist, “A Black-Yellow (and purple) Triumph,” October 3, 2009.
56 Bruce Stokes, “German Elections Presage Troubles,” The National Journal, October 3, 2009.
57 “Deutschland zu neue staerke fuehren,” address by Chancellor Angela Merkel, German Bundestag, November 10,
2009. Available, in German, at http://www.bundeskanzlerin.de/Content/DE/Artikel/2009/11/2009-11-10-
regierungserklaerung-merkel.html; Judy Dempsey, “Merkel Says Worst Still Ahead in Germany,” New York Times,
November 11, 2009.
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it subsidizes employers to keep part-time workers and has said it will implement tax cuts worth
EUR 24 billion (about $36 billion) for companies and the middle class over the next four years. In
advocating a balance between market-led growth and strong social spending, Merkel seems
poised to continue to advocate economic policies based on the traditional social market economy
model. Longer term structural reforms are not expected to feature prominently in the current
government’s plans.
U.S.–German Economic Policy Strains and
Differences
Given weak economic growth and the rising costs of maintaining generous social security
programs, Germany faces budgetary constraints, as do many other industrialized countries. With
dwindling economic and financial resources, Germany arguably has become less willing to
compromise on matters of potential economic advantage.58 In this regard, Germany’s domestic
economic challenges could limit its policymaking flexibility.59 This has affected not only the
economic and trade leadership role that Germany traditionally has played in Europe, but also its
position on issues that directly affect U.S. interests. These include different approaches in dealing
with the global economic downturn and economic sanctions.
Trade Leadership
Germany in the past has been a key ally of the United States on international trade issues. Given
its heavy export orientation and dependence on the international economy, Germany traditionally
has been a strong voice for trade liberalization, both within the EU and the world trading system,
as well as the decisive swing vote between French and British views on trade policy. Every
successful multilateral trade round in the past has depended on Germany to use its bilateral
economic clout to influence the policies of more inward-looking countries in Europe. German
support for a liberal trade policy and generalized opposition to blatantly protectionist proposals,
with few exceptions, has been provided by the major political parties and leading stakeholders in
the private sector. 60
Yet, in recent years, German leadership of the free trade bloc within Europe has weakened. It was
first compromised in the 1990s’ Uruguay Round of multilateral trade negotiations when then-
Chancellor Helmut Kohl backed restrictive agricultural trade proposals the French government
was advocating in an effort to advance European integration. The trend solidified in 2002 when
then-Chancellor Gerhard Schröder agreed with France on setting parameters for agricultural
liberalization within the EU. The same budget agreement on reform of the Common Agricultural
System (CAP) continues to serve as a constraint to achieving a breakthrough in the on-going
Doha Round of trade negotiations under the World Trade Organization.61
58 Alister Miskimmon and James Paterson, “Conclusion: Coping With the Gathering Crisis,” p. 223.
59 Ibid., p. 220.
60Andreas Falke, “The Internationalisation of the Germany Economy,” p. 210.
61 Adam S. Posen, “The United States Needs German Economic Leadership,” Peterson Institute for International
Economics, Policy Brief PB06-1, January 2006.
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Germany is also providing less unconditional support for European integration than it used to,
particularly when the European integration under question entails international trade pressures
from increased labor mobility and low-wage service providers. This was first evident in the
Schröder government’s decision to demand transition periods of up to seven years before granting
full labor mobility to the citizens of new Central and Eastern European EU member states.
Another instance of German opposition to further market liberalization in Europe involved
rejection of the European Services Directive. This directive would have opened highly protected
low-wage services (such as cleaning and transport) and high-wage services (such as public
infrastructure and health) to competition from the rest of the EU—a proposal that was opposed by
unions and the left-wing of the SPD.62
The German government announced in May 2009 that it was keeping labor restrictions in place
on workers from the eight Central and European countries that joined the EU in 2004. The
controls had been expected to be rescinded this year, but Germany invoked a clause allowing two
more years in case of “serious labor market disturbance, or threat of them.” The idea that free
movement of East European labor would threaten “serious disruption” is questionable given that
Germany still has shortages of skilled labor in some areas.63
Chancellor Merkel and the previous grand coalition government faced criticism from within
Europe and elsewhere for its role lobbying General Motors (GM) to sell a majority stake in its
Opel unit to Magna International, a Canadian-Austrian group, and Sberbank, its Russian partner.
In May 2009, the Merkel government approved EUR 4.5 billion (about $6.7 billion) in loan
guarantees to enable the takeover in return for which Berlin reportedly sought a pledge that
Magna would not close factories in Germany where Opel employed some 25,000 workers, half of
its 50,000 employees in Europe. The deal led to speculation that plants in Belgium, Spain, and the
UK would be closed in order to keep the German plants open. This prompted critics, including
the Belgian government, to cast Germany’s action as “protectionist” and raised questions as to
whether the sale would conform to the European Union’s rules on permissible state aid to
companies.64
On November 3, 2009, GM angered German officials by deciding to maintain its European
business and pull out of the Berlin-backed proposal to sell Opel. Chancellor Merkel and others
sharply criticized the decision, which they fear could lead to job losses in Germany. GM will
reportedly seek financial support from European governments to realize its plans to restructure
Opel. However, the German government is expected to show little support for any deal that
involves significant job losses in Germany.65
Responding to the Global Economic Downturn
The United States and Germany have differences over the causes and appropriate policy
responses to the global economic downturn. Obama Administration officials have criticized
Germany for what some consider a relatively cautious response to the crisis. They have also taken
62 Andreas Falke, “The Internationalisation of the German Economy,” p. 219
63 Economist, “Those Selfish Germans, As Germany Becomes Normal, It Looks A Bit More National and A Bit Less
European,” April 30, 2009.
64 Matthew Saltmarsh, “Charges of Protectionism Great G.M.’s Deal on Opel,” New York Times, September 9, 2009.
65 Andrew Ross Sorkin, “Germans Frustrated Over G.M. Keeping Opel,” New York Times, November 4, 2009; Chris
Reiter, “GM Says Opel Reorganization Still Requires State Aid,” Bloomberg, November 13, 2009.
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aim at a perceived German reluctance to support common European approaches to fixing the
banking sector, to join in coordinated cooperative spending programs, and to deal with the
Central European financial crisis.66
German political leaders have vigorously defended their policy response to the crisis, arguing that
they have taken substantial action to stimulate the German economy. They have also urged the
United States and others to commit to an “exit strategy” from fiscal stimulus measures which they
feel could lead to potentially debilitating deficits and dangerous inflation. Moreover, they have
argued that such domestic spending measures will do little to address the root causes of the crisis,
which they tend to view as inadequate regulation of global financial markets. Indeed, many in
Germany view profligate consumption and unregulated markets in the United States and UK as
having been the cause of the global crisis. These critics argue that the downturn could have been
avoided had others behaved as prudently as Germans by cutting wage costs and public
expenditures.
Many U.S. policymakers and politicians counter that Germany shares responsibility for the
downturn because it has run-up large current account surpluses over the last six years. These
surpluses, combined with those run by China and Japan, funneled excess savings to the rest of the
world.67 Under this view, if the United States had not decided to run an accommodating monetary
policy in the 2001 to 2002 period, which contributed to the expansion of easy credit and the
financial crisis, aggregate global demand would have fallen short of supply and unemployment
would have increased worldwide. The imbalances in the global economy, according to this view,
required that the United States serve as the world’s “consumer of last resort” to keep the world
economy growing.68
Many U.S. observers have argued that a reduction of Germany’s large current account surplus
could be a crucial component in the global rebalancing that will be necessary to bring the world
economy back on a more sustainable growth path. As part of this process, domestic demand in
Germany must increase faster than it has in the past. German leaders tend to reject this line of
argument, citing concern that increased spending would impose long-term debt on a shrinking
population and arguing that the basic features of their export-oriented and social market economy
model are solid.69 Even though Chancellor Merkel, at the September 2009 G-20 meeting in
Pittsburgh, signed the leaders’ statement pledging to adopt the measures needed to “lay the
foundation for strong, sustained, and balanced growth in the 21st Century,” most German leaders
66 The United States viewed the Central European financial crisis as primarily an internal European matter, leaving it to
the Germans, French, Swiss, and Italians to bail-out their own banks. But Germany, which had somewhat less exposure
than other European countries, reportedly helped block a European bailout, on the grounds that the IMF should be used
for this purpose. Many in the United States interpreted this as a German effort to secure U.S. and Asian money to deal
with a European problem.
67 The top three current account surplus countries are China, Japan, and Germany. From 2002-2008, China accumulated
surpluses totaling $934 billion, Japan $968 billion, and German $788 billion. In a deep recession, some analysts
maintain that failure of the current account surplus countries to increase domestic demand in a substantial manner is a
form of beggar-thy-neighbor policy as they import demand from the rest of the world.
68 Sebastian Dullien, “After the Election: Germany Will Continue to Obstruct Global Economic Restructuring, AICGS,
June 2009.
69 Stormy-Annika Mildner and Mark Prentice, “Germany’s Social Market Economy: Old Wine in New Bottles?” In
Germany’s Founding Pillars at 60: Future Challenges and Choices, AICGS, The Johns Hopkins University, 2009,
p.16.
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appear to reject the idea that global economic recovery requires fundamental changes in the
German way of doing business.70
Although it was widely criticized for an initially cautious domestic response to the global
economic crisis, Germany has implemented a range of policies to stimulate economic growth and
to support the German private sector. In December 2008 and January 2009, the parliament passed
domestic stimulus measures totaling EUR 71 billion (about $105 billion) for 2009 and 2010.
German officials also emphasize the positive effects on domestic demand of so-called “automatic
stabilizers,” public expenditures for guaranteed social welfare benefits such as unemployment
programs. In total, they estimate that Germany’s fiscal stimulus measures amount to about 1.5%
of German GDP.
Unlike the U.S. focus on increasing consumption, Germany’s stimulus packages have been
geared towards creating incentives for private investment and infrastructure projects, and for
stabilizing exports. Germany’s high household savings rate (11.4% of disposable income in 2008
compared to 1.8% in the United States) has provided the justification for not providing tax breaks
to stimulate consumption. However, the new Merkel government has pledged a series of tax
breaks for companies in the hope that this will decrease unemployment, among other things.
Berlin has also focused on tightening financial regulation.
While most applaud Germany for adopting significant stimulus measures, there is still a view
among some U.S. policymakers that Washington is shouldering the burden of getting the world
economy moving again. Related to this concern is the perception that heavily export dependent
Germany could use demand created by the United States and UK to surge German exports into
these counties as demand rises. Germany would thus benefit from U.S. domestic stimulus as the
United States adds to its domestic debt.71
Merkel has committed her new government to restoring growth to the German economy. The
governing coalition has agreed to pass significant tax cuts for German businesses and the middle
class in the coming four years. However, any additional and broader fiscal spending measures are
considered highly unlikely because of a strong desire to prevent future inflation. The new
government will also be hindered in any effort to support global rebalancing by increasing
German domestic demand by new budget rules approved by the parliament this year. The new
rules, written into Germany’s constitution, the Basic Law, set a legally binding deficit ceiling to
take effect in 2016. Under the constitutional amendment, the federal deficit will not be allowed to
exceed 0.35% of GDP and individual states will be constitutionally barred from running deficits
after 2020. Even if the rule proves impractical and needs to be changed in the future, in the
interim, according to one analyst, “Germany will again try to be more austere than the rest of the
world.”72
Economic Sanctions
The United States and Germany have in the past had policy differences over the use of economic
sanctions as a foreign policy tool. Germany has traditionally been reluctant to use economic
70 Bruce Stokes, October 3, 2009.
71 George Freidman, “The United States, Germany, and Beyond,” Stratfor, March 30, 2009.
72 Sebastian Dullien, p. 4.
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sanctions, despite U.S. urgings. Those in Germany who oppose economic sanctions tend to
question whether sanctions are the most effective means to achieve foreign policy aims. They
argue, for example, that sanctions have at times proved counterproductive by serving to unite
citizens in the targeted country against those implementing them. They add that without strong
multilateral backing, sanctions are likely to fail; if only a few countries continue to trade with the
targeted state, the implementing countries lose their leverage, the argument goes.
U.S. and other critics contend that Germany’s position on sanctions is greatly influenced by
commercial interests and the economy’s strong dependence on industrial exports. German
business groups often oppose calls for economic sanctions and their views are thought to carry
considerable political weight, particularly with the right-of-center CDU and FDP parties. For
example, industrial lobbies have reportedly played an important role in demanding that German
foreign policy elevate commercial relations as a priority factor in Germany’s policies towards
Russia and China, two of its fastest growing markets.73 Observers highlight German policy
toward Iran as the most pertinent example of this influence.
As a member of the so-called EU-3 (France, Germany and the United Kingdom), Germany has
been at the forefront of EU and U.N. efforts to prevent Iran from developing nuclear weapons.
However, of the EU-3, Germany has reportedly been the most reluctant to endorse more stringent
sanctions against Tehran. Berlin continues to face pressure from the United States and others to
limit civilian commercial ties with Iran. Along with Italy and China, Germany remains one of
Iran’s most important trading partners. Although German exports to Iran dropped 25% between
2005 and 2007, they reportedly grew 10% between 2007 and 2008. Germany has in the past
argued that sanctions without Russian and Chinese support would both be ineffective and hurt the
German economy.
On the other hand, Germany’s two largest banks, Deutsche Bank and Commerzbank AG, have
withdrawn from the Iranian market and officials in Berlin report that new export credit guarantees
to companies doing business in Iran have dropped by more than half since 2005.74 While some
interpret weakening German-Iranian economic ties as a sign that Berlin is intent on increasing
economic pressure on Tehran, others argue that German-Iranian trade remains robust and that
politicians in Berlin are unlikely to seek further cuts in commercial ties.75
Currently, German officials reportedly are more inclined to impose economic sanctions on Iran
than they have been in the past, but simultaneously question their effectiveness. Public support
for stronger actions if sanctions fail is also weak in Germany. According to one poll, only one in
five Germans back the option of using military force to stop Iran’s nuclear programs if diplomacy
fails, compared to one in two Americans.76
73 Charles Grant, “Unilateral Germany Threatens to Weaken Europe”, Financial Times, December 14, 2008.
74 Interviews with German officials, June-July, 2009.
75 See, for example, “German Business with Iran Said to Flourish Despite Trade Embargo,” Handelsblatt, January 26,
2009. Accessed through OpenSource, EUP20090126085003.
76 Bruce Stokes, National Journal, October 3, 2009.
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Author Contact Information
Raymond J. Ahearn
Paul Belkin
Specialist in International Trade and Finance
Analyst in European Affairs
rahearn@crs.loc.gov, 7-7629
pbelkin@crs.loc.gov, 7-0220
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