Germany is the world’s third-largest economy and the largest in Europe. Recent performance has not been dynamic, however, and the German economy is vulnerable to external shocks, domestic structural problems, and continued difficulties in integrating the formerly communist east.

From the 1948 currency reform until the early 1970s, West Germany experienced almost continuous economic expansion. Real gross domestic product (GDP) growth slowed down, and even declined, from the mid-1970s through the recession of the early 1980s. The economy then experienced 8 consecutive years of growth that ended with a downturn beginning in late 1992. Since unification, Germany has seen annual average real growth of only about 1.5% and stubbornly high unemployment. The best performance since unification was in 2000, when real growth reached 3.0%. Although final figures are not yet available, most forecasters expected growth of about 0.5% for 2003, with unemployment rising to 10.4%.

Germans often describe their economic system as a “social market economy.” The German Government provides an extensive array of social services. The state intervenes in the economy by providing subsidies to selected sectors and by owning some segments of the economy, while promoting competition and free enterprise. The government has restructured the railroad system on a corporate basis, privatized the national airline, and is privatizing telecommunications and postal services.

The German economy is heavily export-oriented, with exports accounting for more than one-third of national output. As a result, exports traditionally have been a key element in German macroeconomic expansion. Germany is a strong advocate of closer European economic integration, and its economic and commercial policies are increasingly determined within the European Union (EU). Germany uses the common European currency, the euro, and the European Central Bank sets monetary policy.

Despite this external vulnerability, most foreign and German experts consider domestic structural problems to be the main cause of recent sluggish performance. An inflexible labor market is the main cause of persistently high unemployment. Heavy bureaucratic regulations burden many businesses and the process of starting new businesses. German employers, even during periods of relatively fast growth, say they often prefer to invest overseas or install more machinery, rather than make job-creating investments at their domestic facilities.

More than 13 years after reunification (October 3, 1990), Germany has made great progress in raising the standard of living in eastern Germany, introducing a market economy and improving its infrastructure. At the same time, the process of convergence between east and west is taking longer than originally expected and, on some measures, has stagnated since the mid-1990s. Eastern economic growth rates have been lower than in the west in recent years, unemployment is twice as high, prompting many skilled easterners to seek work in the west, and productivity continues to lag. Eastern consumption levels are dependent on public net financial transfers from west to east totaling about $11.5 billion per year. In addition to social assistance payments, the government will extend funds to promote eastern economic development through 2019.

The United States is Germany’s second-largest trading partner, and U.S.-German trade has continued to grow strongly. Two-way trade in goods totaled $89.1 billion in 2002. U.S. exports to Germany were $26.6 billion while U.S. imports from Germany were more than $62.5 billion. At $35.8 billion, the U.S.’s fifth-largest trade deficit is with Germany. Major U.S. export categories include aircraft, electrical equipment, telecommunications equipment, data processing equipment, and motor vehicles and parts. German export sales are concentrated in motor vehicles, machinery, chemicals, and heavy electrical equipment. Much bilateral trade is intra-industry or intra-firm.

Germany has a liberal foreign investment policy. From 1998 to 2001, annual average flows of U.S. direct investment in Germany were $5.4 billion, while those of German investors in the United States reached $27.2 billion. U.S. firms employ about 800,000 people in Germany; German firms likewise employ about 800,000 people in the United States.

Despite persistence of structural rigidities in the labor market and extensive government regulation, the economy remains strong and internationally competitive. Although production costs are very high, Germany is still an export powerhouse. Additionally, Germany is strategically placed to take advantage of the rapidly growing central European countries. The current government has addressed some of the country’s structural problems, with important tax, social security, and financial sector reforms