Germany

By Eurasia Group analysts Irmak Bademli and Wolfango Piccoli

Turkey's ailing bid for EU membership will face greater difficulties following the win of the Christian Democratic Union (CDU) and the Free Democratic Party (FDP) in Germany's recent elections. The FDP's replacement of the pro-Turkey Social Democratic Party (SPD) will allow Chancellor Angela Merkel, who has long favored a "privileged partnership" rather than full membership for Turkey, to become more vocal in her opposition to Ankara's EU entry. Meanwhile, Cyprus remains a major obstacle in Turkey's path to EU membership.

The SPD's exit from power was a major loss for Ankara, which now faces skeptical governments in both Paris and Berlin. The party had been instrumental in tempering Chancellor Merkel's anti-Ankara views during her first term in office from 2005 to 2009. While the FDP's victory does not rule out Turkish membership, leading figures in the party recently said that they do not think Turkey is ready for EU membership due to "major deficits" in Ankara's efforts to meet the EU's criteria.

In the near term, however, the changeover in Germany will not bring a total breakdown in Turkey-EU talks. The ongoing negotiations over Cyprus are entering a delicate stage and Merkel, like other EU leaders, wants to see them succeed.

At the end of 2006, Turkey's refusal to extend its customs union agreement with the EU to Cyprus led the EU to freeze talks over 8 of the 35 policy chapters that each candidate country has to negotiate to become eligible for membership. This fall, the EU will review Turkey's progress in its accession negotiations, in particular focusing on the Cyprus issue. If Turkey has not complied with its customs union obligations by the time the EU carries out its review, some anti-Turkey member states could put pressure on the EU to take sterner action. The European Commission, for its part, is expected to bury its review of the freeze within its larger annual report on Turkey's progress, which will be issued on 14 October.

The EU's options to deal with noncompliance are not clearly spelled out, but they could range from a mild rebuke to further sanctions. A full-suspension of talks, however, is not on the table this year -- despite calls from the Greek Cypriots to punish Turkey if it continues to ignore its obligations. Little progress has been made in the Cyprus negotiations, which began in September 2008, and the failure to reach a settlement by early 2010 could bring a total breakdown in Turkey-EU talks.

While it is hard to trace a sense of urgency on the Greek Cypriot side, the April 2010 presidential elections in the self-declared Turkish Republic of Northern Cyprus (TRNC) are generally regarded as a deadline for the reunification talks. Without a settlement, the present incumbent Mehmet Ali Talat may lose his seat in April 2010 and be replaced by a president less supportive of a settlement. This development will further complicate the already difficult negotiations.

By Eurasia Group analyst Courtney Rickert

Amid headlines that the global economic crisis has stabilized, an important question arises: Which countries' economies will recover most quickly, and which recoveries will be the most sustainable? The key to finding an answer lies in understanding how countries were exposed to the global downturn and assessing their policy responses. Countries that choose to adjust to the changed global economic environment will come out on top in the long term.

While all internationally integrated economies have suffered growth declines, some economies entered the recession in a better position than others. Part of this divergence is a result of the quality of government policies, such as balanced fiscal positions and low inflation. Other key factors in determining a country's exposure to the crisis are trade imbalances and overinvestment in select sectors, such as real estate, in the period leading up to the global financial crisis.

Countries that had persistent trade deficits -- such as the US-financed them by borrowing heavily from abroad. Frequently, international borrowing fed domestic consumption far more than investment. This excess consumption contributed to bubbles during the boom years -- notably in financial assets and real estate-that have since popped. These economies have been slower to stabilize, but the housing and retail markets are naturally adjusting as home prices fall, banks become more prudent, and consumers buy less. In these cases, there is little need for long-term adjustments to macroeconomic policies.

On the other hand, government policy choices will play an important role in countries that sustained trade surpluses, such as China, Germany, and Japan, because these surpluses were a result of government policies that promoted exports. Their economies have been hard hit by declining global demand-particularly in the US. Although government stimulus spending has propped up their economies in the short term, China, Germany, and Japan will face a fundamentally different global market in the long term -- one that is unlikely to revert to the pre-crisis status quo levels of global demand. Governments in these countries will have to choose whether to reorient their economies away from export dependence or try to muddle through and hope for a return of foreign demand.

Effective policy responses in all countries have required crisis stabilization, the cleanup of sectors that experienced overinvestment, and adjustment to the rapidly shifting global flow of funds and goods. Even the best-run governments will face difficulty managing these activities smoothly, but many are demonstrating the ability and willingness to do so. Below are snapshots of policy responses in the four largest economies: the United States., Japan, China, and Germany.

United States
The United States had a large trade deficit during the expansionary period, allowing it to adjust relatively easily to declining global demand. However, as a result of international capital inflows, it also had significant overinvestment in financial assets and real estate. The Obama administration responded relatively aggressively to the crisis by taking action to clean up the financial sector and implementing a $787 billion fiscal stimulus plan, but spending has been slow to materialize. The US economy is forecast to contract by 2.6% in 2009 and show only minimal growth in 2010, as individuals and firms paying down their debts remain a drag on economic growth. But compared to the major trade surplus countries, the United States' relatively fluid economy will likely to adjust to the new global environment more smoothly and rapidly.

Japan
Japan's exposure to the current crisis has been exacerbated by its efforts to sustain trade surpluses, but its economy had already been adjusting before the crisis began, with production increasingly moving overseas. Moreover, when the global decline in demand hit, Japanese firms decreased production and rapidly leveled off at much lower output. In addition, the 30 August elections are expected to displace the long-ruling Liberal Democratic Party (LDP), bringing to power a government that is more interested in protecting the interests of consumers rather than producers. This situation is reducing Japan's dependence on exports, providing a more stable base for growth.

China
The global slowdown has hurt demand for Chinese goods and threatened the vitality of China's export-oriented economic growth. While exports are unlikely to return to their previous levels in the near to medium term, Beijing's massive stimulus spending, relaxed monetary policy, and export promotion will partially counter the collapse in demand. If China is to secure long-term growth, however, efforts to rebalance the economy toward greater domestic consumption -- by putting more income in workers' pockets-must be considered.

Germany
The export orientation of the German economy and tight integration with the wider European economy limits the government's ability to stimulate domestic demand. Moreover, liabilities in the banking sector are worrying. While the government has fiscal room to maneuver, focus on the upcoming election and fears about the cost of potential interventions in both the real and financial sector have constrained Berlin. Most importantly, the government is averse to policies that would lead to a structural change in the country's export orientation. While this could begin to erode after the 27 September elections, any shift in German policy will be limited by concerns about government debt levels.

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