On May 6, Friedrich Merz became the next Chancellor of Germany. In what was meant to be a mere formality of the Bundestag (German Parliament) members electing him to be the next Chancellor, Mr. Merz couldn’t gather enough votes in the first round to be approved by the MPs. This has never happened with any previous Chancellor in post-war Germany. Mr. Merz managed to get 325 votes in the second round (Chancellor candidates need at least 316 votes) and was eventually sworn in. The ruling coalition comprises Mr. Merz’s conservative Christian Democrats (CDU/CSU) and the centre-left Social Democrats (SPD).

Even though migration was one of the key planks that Mr. Merz doubled down on during the election campaign, the focus has once again shifted to the German economy.

Speaking on national TV after becoming the Chancellor, Mr. Merz said, “We are undergoing a profound structural change, but for me the overriding message is that Germany must remain a country of manufacturing industry. We will improve the framework conditions of our economy so that in the coming years we will remain, or again become, an efficient country at the top of the world’s industrialised nations.”

The German economy has shown negative growth for two consecutive years. Things aren’t looking too promising for 2025 either, following U.S. President Donald Trump’s tariff announcements.

Since Mr. Trump’s ‘Liberation Day’ announcement on April 2, imposing 20% tariffs on the EU (now at 10% thanks to the 90-day pause), economic tensions in Germany have been on the rise. Many economic institutes and think-tanks have run simulation studies on the impact this could have on individual EU member countries. Germany, being the country that exports the most to the U.S. (in the EU bloc), faces a lot of challenges.

“The key message to Donald Trump is that Germany is back on track. Germany will fulfil its defence obligations, and it is willing to strengthen its competitiveness. Germany will be a very strong partner within the European Union,” Mr. Merz had said soon after his party won the German elections in February. Mr. Merz also went on to say that President Trump’s policies “increase the risk that the next financial crisis will come sooner than expected.”

Auto industry most impacted

Despite the 90-day pause announced by Mr. Trump, the 25% tariffs on cars and car parts are in place. Germany exported close to 4,50,000 cars to the U.S. in 2024. It’s estimated that the new tariffs would add $6,000 on average to every imported car to the U.S.

“The tariffs place a significant burden on both companies and the automotive industry’s closely interwoven global supply chains, with negative consequences especially for consumers, also in the U.S.A.,” said Hildegard Müller, President of the German Association of the Automotive Industry (VDA).

Sonali Chowdhry, a trade economist at the German Institute for Economic Research (DIW), co-authored a policy brief looking at the impact of U.S. tariffs on the EU.

Quantitative model analysis conducted by DIW and Kiel Institute for the World Economy, note that if there is a protracted trade war between the EU and the U.S. (both regions imposing the same tariffs on each other), then EU exports to the U.S. would be slashed by half. This could have an impact across industries in the EU, noted Ms. Chowdhry.

“Germany, in particular, could be looking at a real GDP contraction of 0.3%. It’s not only the actual tariff increases, but also the uncertainty created by the threats of tariffs that can depress economic activity as businesses and consumers defer investments and purchases,” said Ms. Chowdhry.

Thomas Obst, senior economist at the German Economic Institute (IW), feels that the impact of the tariffs would be immediate in the U.S., while it would build up over time in Germany.

“We, at IW, did a few studies to estimate the impact of Trump’s tariffs on Germany. If the EU is to retaliate with a 20% counter-tariff on the U.S., it could lower the German GDP by up to 1.5% till 2028. In Germany, it would build up over the next four years because of the structure of the economy. We would see second-round effects,” said Mr. Obst. Second-round effects refer to the indirect consequences (from the tariffs in this case) impacting wages, prices, and other economic variables.

‘De-escalate, not retaliate’

As Germany is part of the EU, when it comes to matters around tariffs, it cannot retaliate unilaterally. The EU has little incentive to retaliate, notes Ms. Chowdhry, as most of the EU’s imports from the U.S. are in the areas of oil and gas, pharmaceuticals, chemicals and so on.

“Unless the EU is willing to bear higher energy costs and disrupt these supply chains, it makes more sense to de-escalate rather than retaliate. It is in the EU’s interest to seek an agreement with the U.S., while expanding trade with other partners,” said Ms. Chowdhry.

Mr. Obst concurs. “The EU does not want to retaliate, but offer something on the table that could reduce the tariff impact. It would also signal that the EU is taking a stronger stand against China. The EU has a list of targets and services from the U.S. against which it can retaliate, but that’s not on the table,” said Mr. Obst.

On May 1, European Trade Commissioner Maros Sefcovic agreed to increase imports from the U.S. by an additional $50 billion to reduce the trade deficit, as that’s something that has been pointed out by Mr. Trump. Europe hopes to do that by purchasing more LNG and agricultural products like soybeans.

Additionally, on May 8, the European Commission said that it would launch a dispute with the World Trade Organisation over the U.S.’ tariff policy and duties on cars and car parts, which are as high as 25%. It’s also preparing a list of counter-tariffs on U.S. products, amounting to 95 billion Euros, if trade talks with the U.S. fail.

In its statement, the EU Commission noted that U.S. tariffs “blatantly violate fundamental WTO rules.”

‘Deepening other partnerships’

“A more long-term strategy for the EU would be to deepen its trade relations with existing partners such as Canada, Mexico, Japan, South Korea, among others. Deepening trade with these partners and expanding free trade agreements (FTA) partners would neutralise the economic damages from U.S. tariffs,” said Ms. Chowdhry, noting that this would increase the resilience of EU industries from future shocks like climate disruptions and geopolitical tensions.

India could be a potential beneficiary if the EU decides to double down on expanding its FTAs.

“While a deep EU-India FTA would be difficult to realise soon, sectoral agreements (for instance, in the area of industrial goods) that focus on tariffs would be more feasible,” said Ms. Chowdhry.

Mr. Obst noted that the EU-Mercosur FTA (a proposed trade agreement between the EU and the Mercosur countries (Argentina, Brazil, Paraguay, and Uruguay)) has the potential to kick-start a lot of positive things for Europe.

“With India, there is no FTA on the horizon. However, the first international trip by the newly formed EU Commission was to India, which says a lot. India is seen as a partner in the Asia region, a very attractive market, but it’s also very protectionist,” said Mr. Obst.

Political challenges

Mr. Merz is perceived as a divisive figure, and this was on display when it emerged that members of his own coalition voted against him in the first round on May 6. If Mr. Merz hadn’t secured enough votes in the second or consecutive rounds, it could have created further confusion as to who would lead the next German government. The stock markets reacted negatively after the first round of voting on May 6 as well. This shaky start to the new government has raised doubts about whether this coalition could survive the four years and solve Germany’s economic woes.

Mr. Obst expects stronger leadership from the coalition of the CDU/CSU and the SPD.

“They seem to understand the economic situation and are willing to do something about it, compared to the divisive coalition in the earlier government,” said Mr. Obst.

However, the far-right Alternative for Germany (AfD) has a strong participation in the Bundestag. It’s the largest Opposition party, and in terms of new economic reforms, it could create disruptions.

Mr. Obst noted that corporate taxes in Germany (at 30%) are the highest among the EU and OECD countries.

“In the coalition talks, it has been agreed to reduce that by up to 5%, but only after 2028. In the meantime, the coalition needs to do something to spur investments and incentivise companies to invest in Germany,” said Mr/ Obst.

“The bureaucracy also needs to be brought down, not just in Germany but EU-wide. It needs a systematic and comprehensive reform agenda to have a lasting effect on the economy,” said Mr. Obst.

Fears of Chinese dumping

While Mr. Trump announced a 90-day pause on tariffs for most countries, there was one country that did not get that benefit—China. On April 9, the tariffs directed at China stood at 145%, with China announcing counter-tariffs of 125% on U.S. imports.

It was only on May 12 that the Trump government announced a 90-day pause on tariffs towards China, which now stand at 30%.

However, in many circles in Germany and Europe, there are fears that this will lead to China dumping its excess production in Europe.

According to Ms. Chowdhry, China can reroute trade flows to Europe. “The EU must be very careful in its response to this, as it cannot afford to be drawn into a global spiral of protectionism. The EU should continue to use more targeted instruments to address dumping issues and not take a heavy-handed approach,” she said.

European Commission President Ursula von der Leyen has spoken to China’s Premier Li Qiang about setting up mechanisms to track trade diversions. As per an EU Commission release, “President von der Leyen emphasised China’s critical role in addressing possible trade diversion caused by tariffs, especially in sectors already affected by global overcapacity.”

Mr. Obst feels the dumping will depend a lot on which sector is involved.

“When it comes to standardised goods, it’s not a big deal as Germany or the EU do not directly compete with China on that front. One industry that is very concerned is the automotive industry. That is one of the reasons the EU introduced tariffs against EVs imported from China last year. China has heavily subsidised the EV industry and its supply chains, and the EU will have to act accordingly to protect its industries,” said Mr. Obst, noting that Germany is concerned with sectors producing goods that add high value to the economy.

According to a report by Bruegel, a Brussels-based think tank, the most exposed category is ‘electrical machinery, equipment and parts thereof’, for which Chinese exports to the U.S. were around $124.8 billion in 2023.

“Smartphones and lithium-ion batteries account for 31% and 10% of this category, respectively. The EU produces virtually no smartphones but wants to increase its share of global battery manufacturing,” notes Bruegel.

“Trade uncertainty as a result of the U.S. tariffs is a pressing concern for an export-oriented nation like Germany, which is specialised in industries that have extensive global value chains. There are also a lot of domestic concerns and long-term issues, such as improving productivity and innovation, that need to be addressed. For the incoming government, this will be high on the policy agenda,” said Ms. Chowdhry.

(Nimish Sawant is an independent journalist based in Berlin.)