The German Economy and U.S.-German Economic Relations

Raymond J. Ahearn
Specialist in International Trade and Finance

Paul Belkin
Analyst in European Affairs

Germany is the world's fifth largest economy and the largest in Europe, accounting for about onefifth 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 have been exacerbated by a steep 5% 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. 


Date of Report: January 27, 2010
Number of Pages: 25
Order Number: R40961
Price: $29.95

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