Key takeaways
• Growth is slowing. The IMF forecasts 1.5% growth in 2017 and 2018, lower than 2016’s estimated 1.7%—due to fewer working days in the year and a more risky economic environment.
• Voters go to the polls in September and Chancellor Merkel is facing her toughest election. As of now, she is expected to win her fourth term, but the domestic political scene remains highly unsettled and subject to vagaries of current events.
• Germany faces many daunting challenges in 2017, including integrating refugees living in the country and stemming the inflow of new immigrants; boosting economic growth and social inclusion; negotiating Brexit and sustaining a united Europe; managing ongoing financial crises in Greece and Italy; upholding Russia sanctions; navigating tense relations with the US and European neighbors; and thwarting domestic terrorism.
• German public opinion about the US President is sharply negative, but Merkel’s public statements about Donald Trump have been diplomatic despite Trump’s provocations. In the run-up to the election, Merkel will have to balance domestic public opinion with her role as champion of liberal democratic values, openness, and globalization and maintain Germany’s close trade and diplomatic ties with the US.
Economic developments
Domestic outlook
Despite the recent improvement in Europe’s economic outlook, Germany’s GDP growth rate is expected to drop in 2017 to 1.5%, lower than 2016’s estimated 1.7% The decrease is partially attributable to the smaller number of working days in 2017 and partially to geopolitical uncertainty, which is expected to lower overall exports by decreasing equipment investment, despite strong levels of capacity utilization. Demand for German exports is also likely to suffer given the political and economic uncertainty in several EU countries.
Germany’s main economic driver, private consumption, is also expected to decline in 2017 because of slowing employment and income growth, although the drop should be mitigated by the low unemployment rate of around 4%. In addition, the public budget surplus will decrease dramatically in 2017, to 4 billion euros from 26 billion euros at year-end 2016, and a small deficit is expected for 2018. The decreasing surplus is mainly attributable to the slower employment growth (and lower tax revenues) and increases in public spending—most notably for public sector pensions and refugee integration.
Regional tensions
The European Central Bank plans to continue its quantitative easing program through 2017, in part to bolster the southern eurozone’s fragile economies. But Berlin has pushed back on the program, most recently by citing increased inflation stemming from rising energy prices.
The resurgence of the Greek debt crisis is also creating challenges for Germany. The IMF is resisting further bailouts for Greece and is keen to pass more of the burden along to the EU, causing division in Europe over how to handle the next round of bailouts given that both the German and the Dutch parliaments require full IMF participation. The next round of Greek debt repayments, totaling 7 billion euros, is set for July, and European governments are hoping to get the matter resolved before the issue becomes a political football in countries’ elections later this year.
In addition, two of Italy’s largest lenders, Banca Veneta and Banca Popolare di Vicenza will likely require a 5 billion euro recapitalization to remain solvent. Yet this plan requires a sign-off from the EU to move forward, and there are doubts about whether this will happen given that Italy’s banks received a 20 billion euro injection as recently as December—but Italy’s banks have nearly 316 billion euros in bad loans on their books (about one-third of the eurozone’s total).
Thanks to lax ECB monetary policy, the euro currently is trading significantly below its fair-market value, creating political pressures for Berlin (see valuation chart). Peter Navarro, the head of Trump’s National Trade Council, in late January, asserted that with the weak currency, Germany “exploits” the US and its European neighbors. The European Commission also has repeatedly criticized Germany for maintaining a large current account surplus—which Berlin sees as a sign of economic strength.
Political developments
Election season
Merkel is up for reelection on September 24, and while most pundits have predicted that she will win, the country’s political climate is very volatile and the election is too early to call.
Recent talk on the elections has focused on the surge in popularity for the Social Democrats (SPD). Martin Schulz is the new leader of the party, and as a fresh face on the political scene, his policy positions are not well known. The party has been bolstered by the February 12 election of popular SPD policymaker Frank-Walter Steinmeier to the largely ceremonial role of president. Steinmeier is a charismatic and a well-liked player in the government, so after taking office on March 18, he should be able to use his platform to support the SPD in the lead-up to the September elections.
Merkel is facing her toughest election. While she is credited with leading Germany and Europe through a period of significant challenges, an October Ipsos MORI poll indicated that about 70% respondents felt the country was on the wrong track, with poverty and social inequality cited as the biggest concerns. Should Schulz win and manage to form the first-ever leftist coalition with the Greens and Die Linke (the party of former East German communists), German policy would be altered quite significantly—away from fiscal austerity and the business-friendly stance of the Merkel coalition toward support for greater social security and economic inclusion.
Recently, Merkel’s Christian Democratic Union and Schulz’s SPD have been running neck and neck, each with around 30% of public support, with the right wing Alternative für Deutschland (AfD) polling between 10% and 15%.
Of note, the AfD is attracting voters under the age of 30, which has caused significant divisions in the country. Approval for the party surged in aftermath of the refugee crisis, resulting in major successes in three state elections in March 2016. Those who support the AfD express fatigue with apologizing for Germany’s past and feel as though the country is carrying too much of the burden for supporting Europe. Those opposed to the AfD are fearful of its parallels to Germany’s Nazi past. The most recent polling suggests that support for the party is waning as Germans look across the Atlantic and get nervous about the rightward shift and political volatility in the US. A strong showing by the extreme right in upcoming elections in the Netherlands and France, however, could bolster the AfD.
Meanwhile, German policymakers are closely watching for possible Russian interference in the elections. There are already allegations of the Russians exaggerating news about crime to foment fears about immigrants and increase support for the AfD.
Refugees
The flood of refugees into Germany has abated…for now. The number of asylum seekers fell sharply in 2016, to approximately 280,000, down from an estimated 900,000 in 2015. The Merkel government has been heavily focused on immigrant integration since then. Migrants tend to concentrate in the five largest cities, where jobs are most plentiful: Hamburg, Cologne, Frankfurt, Munich, and Berlin. So to avoid “ghettoization” in these cities and to support economic growth in smaller towns, the Integration Act, passed in August 2016, distributes asylum seekers around the country, and some migrants are required to stay for up to three years in those locations.
With low unemployment and an aging labor force (the median age in Germany is 45.9 years, versus 42.4 years across the EU), Germany is seeking to partially offset its demographic challenges by integrating the newcomers. Just over one-fifth of the population is foreign born, and while a lot of attention is focused on those immigrating from the Middle East, most recent arrivals are from other parts of Europe (see source countries chart).
Merkel has brought together leading companies (including Siemens, Deutsche Bank, Opel, Volkswagen, Daimler, Hugo Boss, RWE, BASF, and Bayer) under an initiative called Us Together, in which the companies have made non-binding promises to train and hire migrants. The program is in conjunction with the labor ministry’s plan, announced in April 2016, to subsidize the creation of 100,000 low-paying, low-skill jobs for migrants and asylum seekers. (In July 2016, 600,000 low-skilled/unskilled positions throughout the country were unfilled.) Five months after the Us Together program was announced, reports were leaked that companies had hired fewer than 100 migrants, 50 of whom had been hired by the logistics company Deutsche Post.
Major hurdles for companies that want to hire migrants include uncertainty regarding a potential job candidate’s long-term legal residence status, the necessity of obtaining residency permits and banking privileges for any nonnative employee, and the potential that the candidate has insufficient German language skills for the intended position. Under the Integration Act, the federal government has tried to address employment concerns and put a renewed focus on integrating migrants into German society. Namely, the act gives migrants better labor market access and requires attendance for migrants with a high probability of long-term residence in fully funded language and integration classes, including up to 900 hours of training and coursework on German cultural norms and values.
Despite these integration efforts, Merkel’s approval rating has suffered from her handling of the refugee influx (see approval rating chart). In early December 2016, she sought to outflank the populists by embracing the idea of burqa ban. And Merkel’s popularity has generally improved in the past few months, even following the December 19, 2016 attack on a Berlin Christmas market, orchestrated by a Tunisian failed asylum seeker.
Germany-US relations
Germany is one of the US’s closest and strongest allies. In 2015, the US became Germany’s fourth-largest source of imported goods, and the US became Germany’s leading export market. Germany, in turn was the fifth-largest exporter of goods to the US in 2016, running a significant trade surplus.
The Trump administration’s calls for protectionist trade policies worry the Germans. In addition, Trump has called Germany’s openness to refugees a “catastrophic mistake,” and he has signaled a desire to ease sanctions against Russia, which Merkel has forcefully rejected. Furthermore, Trump’s statements while he was a presidential candidate have created considerable unease, particularly his reference to NATO as “obsolete,” his derision of the EU, and his praise of the UK’s Brexit vote.
Yet Merkel has remained diplomatic throughout, even though she distinguished herself among European leaders after Trump’s election victory by combining a congratulatory statement to the US president-elect with a subtle admonition: “Germany and America are connected by values of democracy, freedom and respect for the law and the dignity of man, independent of origin, skin color, religion, gender, sexual orientation, or political views.” She sternly added a caveat: “I offer the next president of the United States close cooperation on the basis of these values.” Merkel has remained firm in her tone on rights issues, calling on Trump after his travel ban was announced to live up to the responsibilities embedded in the US’s international agreements on the treatment of refugees, arguing through her spokesman that “the necessary, decisive battle against terrorism does not justify a general suspicion against people of a certain origin or a certain religion.”
As a result of this dramatic political shift in the US, German public opinion on the US has suffered. In 2009, the US reached its all-time high rating on a monthly poll by Cologne-based radio station WDR about the trustworthiness of Germany’s international partners. From the high point of 80% of Germans thinking the US was trustworthy in 2009, the US under Trump has now reached an all-time low rating: only 22% believe the US is trustworthy. This is only one percentage point more than positive views of Russia. Additionally, 80% of Germans think the EU needs to unite in order to face Trump, and 67% declare a fear that Trump’s policies will negatively affect the German economy. Not surprisingly, Merkel is being criticized by the Social Democrat Schulz for being too diplomatic, and Steinmeier has been a vocal critic of Trump and predicted “difficulties” in relations with the US. The AfD, on the other hand, has praised Trump’s seven-nation immigration ban and is hoping to benefit from the American populist wave.
Given the disquiet among German leaders, US officials such as Vice President Mike Pence, Secretary of State Rex Tillerson, and Secretary of Defense James Mattis have recenty visited Germany and offered assurances about continuity in US values, open trade relationships, and commitment to a strong EU. But the erratic nature of the first 40 days of the Trump administration set a tone that has engendered a deep uncertainty and unwillingness to trust conciliatory statements coming from the US.
Over the next several months ahead of Germany’s general election, Merkel will have to balance the critical public opinion of the US and her role as the “last defendant of liberal democratic values” with the need to maintain close trade and diplomatic relations with the US. She is expected to take her trademark approach: careful and step-by-step. At the same time, EU leaders have begun to discuss the need to strengthen their own internal political, economic, and militarily ties—including a potential pivot to Asia—as a hedge against American isolationism and willingness to act unilaterally.