Old Europe is winded. The German economy failed to grow at all in 2024, succumbing to recession for the second straight year. And France had nothing to brag about: its economy expanded by an anemic 1.1 percent in 2024, less than half the rate of the United States.

Major German companies, from Bosch, the number one supplier of car parts, to ThyssenKrupp, the leading steel producer, announced their intention to close down manufacturing plants. In France, deficit spending by the government sustained domestic demand a bit better, but saddled the country with trade deficits and added to an already frighteningly large public debt. These woes have deepened public dissatisfaction with economic management in both countries, fueling support for extremist political parties and precipitating the collapse of mainstream governments. The resulting uncertainty has further undermined consumer and investor confidence, exacerbating already daunting economic problems.

The conventional narrative blames the two countries’ plight on economic miscues over recent decades. Germany became heavily dependent on imports of natural gas from Russia even as it caved to Green demands to abandon nuclear power, not imagining that Vladimir Putin would invade Ukraine and precipitate a scramble to replace Russian energy. In these same decades, Germany increased its dependence on exports as a source of aggregate demand, making it exceptionally vulnerable to the slowdown in China’s growth. Germany, moreover, was late to contemplate, much less complete, the transition from internal combustion engines to EVs and from an analog to a digital economy.

The French government, for its part, spent like there was no tomorrow, propping up a bloated welfare state and accumulating a public debt that is enormous even by U.S. standards. Now that anger over disappointing economic performance has fed political polarization and caused governing coalitions to splinter, both countries are left leaderless, politically and economically.

Like many conventional narratives, this one has more than a little validity. But it is not the whole story. Nor does it explain why German and French leaders piled strategic error on error, or why they seemingly were – and are – unable to correct them. Here, a little history is needed to understand why both countries have dug themselves into such deep economic holes. The explanation really goes back to the turbulent aftermath of World War II, when both adopted economic and political institutions appropriate to the era but ill-suited to a highly competitive global economy.

Rooted in a Bygone Era

Start with postwar Germany. To regain a foothold in precision manufacturing, West Germany adopted vocational training and apprenticeship programs to ensure the avail availability of skilled mechanics and technicians. Taking advantage of voracious demand for capital goods in the aftermath of the war, it doubled down on energy-intensive industries producing steel and transport equipment. And it expanded its bank-based financial system to channel funds to dominant firms in these sectors. Then to limit workplace disruptions, the government developed a system of management “co-determination” that gave workers input into – and thus a measure of responsibility for – C-suite decisions. The results were nothing short of miraculous growth, which is why Germans refer to their economy’s performance in the third quarter of the 20th century as the “economic miracle,” or Wirtschaftswunder.

Where Germans celebrate Wirtschaftswunder, the French look back fondly on Les Trente Glorieuses, the three postwar decades when economic growth averaged 5 percent, two and a half times the 1914-45 average. This growth was anchored on close collaboration between business and an elite civil service. The government played a key role, investing heavily in infrastructure and using the financial system (which it controlled) to extend credit to industrial enterprises investing in modernization and capacity expansion.

The General Planning Commission (Commissariat Général du Plan) was tasked with identifying bottlenecks, input shortages and coordination problems – in other words, instances in which separate industries needed to get up and running simultaneously in order for any of them to be competitive. In addition to state direction of credit, officials used export subsidies, tax breaks and lookthe- other-way antitrust policy to build a formidable industrial base.

Leading firms, including Renault, Air France, the big banks and critical enterprises in the energy sector, were nationalized under the direction of France’s dominant postwar leader, Charles de Gaulle. When financial incentives did not suffice, the authorities could simply instruct management when and where to expand capacity and production. And as long as the planners could look to the United States, which led in modern mass production, and to Germany, the European leader in capital goods, to see what worked, the results were positive – yes, even glorieux.

Unplanned Obsolescence

With time, however, the focus on manufacturing became problematic. Energy-intensive production of steel and chemicals became increasingly fraught after the OPEC cartel oilprice shocks of the 1970s, and matters only became more challenging with the rise of the energy-famished Chinese juggernaut.

Meanwhile, attempts to alter workplace organization in response to globalization pressures were stymied by co-determination in Germany and entrenched organized labor in France. This allowed workers to push back effectively against change – though more so in Germany, where workers’ representatives were actual voting members of corporate boards, than in France, where they only had to be consulted. Moreover, top-down “indicative planning,” as state direction of resources in France was known, became harder to get right as the pace of global technological and managerial change accelerated.

The planners had at their disposal sophisticated “input-output models,” mathematical representations of linkages among existing sectors. But lacking the benefit of signals from the free market, these provided little help in choosing among new products and technologies. Remember, too, that funding startups in frontier sectors did not come naturally to the French (or German) financial systems, which were dominated by fusty banks answering to the government’s beck and call and accustomed to dealing with long-established customers engaged in familiar lines of business.

In Germany, there was no shock of sufficient severity to prompt a fundamental rethink. In the fourth quarter of the 20th century (as in the third), Germans regarded their economy as the strongest in Europe. But its strength reflected fortuitous economic developments as well as residual advantages of business-as-usual.

For starters, Germany’s focus on capital goods received a timely boost from completion of Europe’s single market, which gave German companies assured continent-wide market access on top of a whole new market in China. Then, too, the motor vehicle industry benefitted from America’s embrace of free trade and the failure of the long-protected Big Three American automakers to adapt rapidly to foreign competition. German car producers capitalized further on the fall of the Soviet bloc and the accession of some of its successor states to the European Union, where they became plentiful sources of skilled, low-cost labor.

Don’t forget that the country met its growing energy needs by building on West Germany’s earlier policy of Ostpolitik, or opening to the East. Smoothing relations with the Soviet Union with an eye toward possible German reunification was the brainchild of early-70s chancellor Willy Brandt. Germany provided the Soviet Union with pipes, machinery and finance to purchase these inputs. In return, the Soviets sold gas to West Germany and its European allies. By the mid-1980s the flow was accommodated by a vast network of pipelines linking Siberia to Western Europe.

Thus, Angela Merkel’s decision in 2007-8 to greenlight the construction of the high-capacity Nord Stream 1 pipeline connecting Russia to Germany under the Baltic Sea had an important precedent. Brandt’s earlier choice to rely on the Soviets for energy had turned out well, it seemed. Merkel was optimistic that the same would hold true for Nord Stream 1 and, eventually, for a second Baltic pipeline, Nord Stream 2.

Moreover, even if there had been reason to alter this economic model, doing so was easier said than done. Change is usually hard, but it is especially hard when one seeks to modify a set of institutions whose successful operation, in each case, depends on the operation of the others. Attempting to do so is a bit like changing out the transmission of a Volkswagen while the engine is running.

To take one example, German banks are most comfortable lending to long-established firms doing business in long-established ways. In turn, those firms do best when they have longstanding relationships with banks on which they can rely for finance. Replace those established firms with startups, and then the banks, lacking the expertise of venture funds, will be at sea. If they lend nonetheless, they are at risk of going under. Replace banks with venture capital funds, which have little interest in stodgy metal-bending firms, and those firms will then lose access to the external finance on which they depend. Such is the nature of Germany’s institutional gridlock.

German reunification in the 1990s was undoubtedly the most serious economic shock of the period. Investment in the west declined as close to $2 trillion worth of resources were reallocated to tasks ranging from repairing roads to updating telecommunications networks in the east. Meanwhile, the legendarily tight anti-inflationary monetary policies of Germany’s central bank led to slower growth, an overvalued currency and declining export competitiveness.

With the economy operating at less than full capacity, less-skilled workers in western Germany found themselves competing for work with their counterparts in the east. Unemployment in the western states reached 9 percent in 1997 – extraordinarily high by German standards – and remained elevated into the new millennium. This proved enough of a shock to get the attention of leaders across the political spectrum and to elicit concessions from Germany’s powerful unions.

Enter the Hartz reforms, named after Peter Hartz, the human resources director of Volkswagen, aimed at creating a more flexible labor market capable of adapting to domestic dislocation and evolving international competition. Starting in 2003, part-time employment was no longer discouraged, government loans were redirected to small and mediumsized businesses that hired the jobless, and grants were extended to startups. These carrots were matched by the stick of benefit cuts of up to 30 percent for the unemployed who refused reasonable offers of work.

This was not quite a wholesale move to an Anglo-Saxon-style flexible labor market. Nor was it matched by significant changes in Germany’s vocationally oriented apprenticeship system, its conservative bank-based financial system, or its Russia-dependent energy system. And this lack of complementary measures rendered the Hartz reforms a mixed blessing from the point of view of efficiency and economic growth. Economist Simon Woodcock (Simon Frazer University) found that displaced workers were increasingly employed in temporary low-wage positions that limited the on-the-job training traditionally enjoyed by workers in Germany’s celebrated Mittelstand (the country’s dynamic medium-sized businesses).

Collective Anesthesia

France, for its part, had experienced a comparably severe shock to its economy and collective confidence several decades earlier. French leaders had remained firmly committed to their top-down approach to economic management. But with the exhaustion of the earlier backlog of unexploited catch-up technologies, identifying and promoting vanguard industries became harder. While high-tech “grand projects” succeeded in nuclear power and high-speed passenger rail, they failed in supersonic passenger aircraft, consumer electronics and mainframe computers. The government responded by pouring resources into old and new sectors alike with the goal of protecting jobs.

In the 1970s, excessively expansionary policies twice pushed the French franc out of the colorfully described European currency snake, the pegged exchange rate arrangement established following the collapse of the U.S.- led Bretton Woods System. When the socialist government of François Mitterrand attempted to jumpstart the economy in 1981- 83 by nationalizing still more firms and applying another dose of monetary and fiscal stimulus, a third even more serious currency crisis loomed. France’s claim to be the coleader (with Germany) of Europe’s project for European integration hung in the balance.

The Mitterrand government and its successors on both the center-left and center-right responded by recommitting to European integration and rolling back elements of France’s top-down economic model. They managed just enough fiscal and structural reform to remain members in good standing of the European Community (the precursor to the European Union). They abandoned directed credit, price controls and sector-specific industrial policies. They pulled back from the grand project approach. And they privatized a number of public enterprises.

Importantly, however, French leaders achieved this shift by buying off the opponents of change, further entrenching a wide range of labor and social protections. Politicians were all too aware of the long-standing French practice of contesting political and economic decisions in the streets extending back to the revolutions and communes of the 19th century. More recently, they had seen the right-wing populist Poujadist movement, which gathered force among the lower-middle classes and small farmers in the south in the 1950s, along with the near-revolution of May 1968, which was led by students and trade unionists.

These revolts showed how interest groups might mobilize against the modernizing efforts of the state. By no coincidence, workers at risk of separation from newly privatized enterprises were offered generous income replacement, early retirement and ample pensions. Minimum wages were raised to exceptional heights even by European standards. And to further neutralize opposition to change, Paris acquiesced in the provision of extended parental leave, paid holidays and short workweeks. My Cal Berkeley colleague, political scientist Jonah Levy, refers to this as a turn from the dirigiste (top-down) state to the “social anesthesia state.”

This approach to managing discontent had two unintended, if predictable, consequences. First, it encouraged those on the receiving end of this largess – farmers, industrial workers and university students among them – to make common cause to protect their benefits. The “yellow vest” protests of 2018-19, echoing the earlier Poujadist movement, are only the most recent manifestation of this practice.

France continues to restrict fixed-term and part-time employment of the sort made possible in Germany by the Hartz reforms. And unlike Germany, it does little to penalize the unemployed refusing reasonable offers of jobs. Pension reform, labor market reform and product market reform all remain incomplete. Even privatization remains incomplete in the sense that French governments continue the tradition of bailing out privatized companies.

Thus France’s transition to a flexible economic model remains only partial. And policymakers, including the current embattled president Emmanuel Macron, continue to take a strongly top-down approach to economic management.

Second, buying off interest groups has strained the government’s budget, as politicians time and again go back to the well to pacify unhappy interests that hold de facto veto power over major reforms. It should not be surprising, then, that (a) at 58 percent, France has the highest share of government spending in national income of any European country, (b) France chronically runs budget deficits far exceeding European Union limits and (c) France has a public-debt-to-GDP ratio of more than 115 percent. It would be unfair to lay the blame entirely on François Mitterrand, or on Emmanuel Macron for that matter. These problems have deep historical roots.

Piling On

Start with the reality that Germany has entered a period of steep demographic decline, with its working-age population forecast to fall even more rapidly than in Japan. The economic consequences have been deferred by a surge of immigration (both legal and illegal), where the newcomers were primarily of working age. But thanks to a fierce political backlash led by Germany’s proto-fascist party, the Alternative for Germany (AfD), the surge is over. A growing elderly population requires the devotion of more resources to pensions and health care, less to R&D and other investments. Research suggests that population aging combined with the birth dearth will reduce per capita output growth by 0.8 percentage point annually over the next two decades, at the end of which per capita output will be 17 percent lower than otherwise.

To regain a competitive edge, the country’s car companies have accelerated their shift toward electric vehicles. And more generally, German producers have moved up-market into the production of higher value-added products. But Chinese competitors have moved up-market as well and are now poised to become the leading exporters (as well as the leading producers) of EVs. They have German producers and the German market directly in their sights.

Success in regaining industrial leadership will require more than a facelift. And here, codetermination is a barrier if not a deal-breaker. When Volkswagen announced a plan to close three of the company’s German factories and cut pay at its remaining plants last year, workers’ representatives on the VW board pushed back. The company’s politically powerful union, IG Metall, enlisted labor-dependent German Chancellor Olaf Scholz to back their case. And last December, Volkswagen surrendered, agreeing not to close factories and to reduce its workforce exclusively by attrition.

To compete effectively, German firms also require world-class infrastructure. Unfortunately, Germany is behind most other advanced economies on this score. Net public investment has been near zero for a quarter of a century – that is, investment barely offsets depreciation. And it shows: railways, whose on-time records Germans once pointed to with pride, are regarded with derision.

The big constraint here is Germany’s debt brake, the fiscal rule built into the constitution that limits the annual structural federal deficit to 0.35 percent of GDP. (That’s 0.35 percent of GDP, not 3.5 percent of GDP!) Transfer payments that fund the safety net along with other beneficiaries of spending are notoriously difficult to reduce, so when budget cuts are unavoidable, they come out of investment. And given Germany’s obsession with deficits, those cuts have been happening for 25 years.

Look closely and other problems appear. With its focus on mechanical engineering excellence, Germany has been slow to turn to digital services. Manufacturing continues to account for 30 percent of German GDP, compared to 18 percent in the United States. By no coincidence, just 49 percent of Germans possess basic digital skills; in the EU, only Lithuania, Italy, Poland, Bulgaria and Romania rank lower. Digital startups are thus hindered by a shortage of appropriately skilled workers, but also by lack of access to venture capital, whose supply relative to GDP is only half that of the United States. When startups do manage to gain a foothold, they are apt to move abroad where the funding for capacity expansion is readily available.

While France ranks ahead of Germany in terms of the share of its population with digital skills, its bias toward giant “national champions” has deprived startups of the resources to scale up. What’s more, established businesses have been notoriously slow to utilize new digital technologies – and have been able to get away with it in part because France is notorious for turning a blind eye toward anti-competitive practices.

It shouldn’t be surprising, then, that France is far below the OECD average in terms of the share of firms offering ICT training to their employees. And while the country’s elite institutes of higher learning remain world class, employers complain about the general decline of educational standards – and in particular a sharp drop-off in mathematical capabilities since math requirements in the national curricula were loosened in 2018. A 2019 survey placed France last in the EU in math for fourth graders and second-to-last for eighth graders.

Although tax incentives for research and development in France are among the most generous in the advanced-economy world, R&D spending by business is significantly t k Second Quarter 2025 21 below the OECD average. France has a reputation for innovation, but its firms lag in the indirect signs of innovation revealed by trademark applications and the marketing of new products.

The news is not all bad on the growth front, though. While fertility rates are trending downward, the decline has been slower than elsewhere in Northern Europe. Indeed, in 2022-23, France had the highest total fertility rate of any European country. Old-age dependency ratios will inevitably rise – but less rapidly than in other European countries.

Consider, too, that because France made a big bet (and, with hindsight, a smart one) on nuclear power, energy prices are below those in Germany (fully one-third lower in the first half of 2024). The share of manufacturing in GDP is only half that of Germany, which offers more insulation from the competition from China and other emerging economies. Note, too, that on the export side, France is less exposed than Germany to the Chinese market.

Thus, the most pressing problem in France is not demography, deindustrialization, high energy prices or Chinese competition, but the looming fiscal crisis. Late last year, the budget deficit was revised upward to an eye-watering 6.1 percent of GDP. And in December, the French government was forced to pay a remarkable 88 basis points (0.88 percentage points) more than their German counterparts to sell 10-year bonds.

There is not much wiggle room for fixing the fiscal mess by boosting revenues. In the EU, French taxes as a share of GDP are second only to Denmark. A parade of prime ministers – four in 2024 alone – proposed measures to narrow the fiscal gap, mainly by cutting spending, but opposition to these cuts is as strong as ever.

It is thus all too easy to imagine a crisis similar to Greece’s experience in the wake of the Great Recession, where investors threw up their hands over the government’s inability to rein in deficits. In this scenario, bond prices would plunge and interest rates would shoot up (more). Since France is too big and too important to the European project to be allowed to fail, the European Central Bank would ultimately step in, supporting the market with bond purchases. But this manifest evidence that France was unable to get its fiscal house in order, along with uncertainty about the ECB’s willingness to step up a second time if the need arose, would saddle France with austerity budgets, high unemployment and uncertainty that would discourage private investment. In other words, Greece redux.

Dysfunctional Politics

In principle, these problems have less-than-agonizing solutions because, fundamentally, both economies are highly productive. Germany could relax its debt brake and use deficit spending to invest more in infrastructure. It could address demographic decline by accepting more immigrants – or, more realistically given the times, by strengthening work incentives for women and aging workers. (Two million fewer women than men are in the labor force, and women are five times more likely to work part-time.) Wider public provision of childcare along with tax reforms that reduced penalties for secondary earners could make a dent in this imbalance.

By the same token, Germany could step up by modernizing its education and training policies to reflect contemporary market requirements. Pushing ahead with Capital Markets Union, an ongoing but incomplete EU project to integrate member-state financial markets, would reduce the dominance of conservative-minded banks in the financial system and make it easier for startups to source venture capital.

France, for its part, could swallow the red pill and finally confront entrenched interests. Automatic increases in old-age pensions could be slowed. Redundant public sector employees could be laid off. Subsidies for all manner of activities could be scaled back. Tax expenditures – subsidies by another name – could be cut. For example, exemptions on fuel taxes for agriculture, fisheries, construction and road haulage vehicles could be eliminated both saving money and accelerating the transition to alternative fuels.

The rub, of course, is that to be sustainable such reforms require broad-based support that lasts beyond a single election. Here, obviously, both political polarization and deep fissures within mainstream political parties stand in the way. To be sure, it is not only in France and Germany where opposition to structural adjustment and reform comes from political opportunists riding the wave of populism. But the issues are especially daunting in these two countries because of the structures of their political systems.

Consider Germany. To check the kind of political extremism and parliamentary fragmentation that helped bring the Nazis to power in 1933, the postwar Federal Republic adopted a proportional electoral system. This assigned seats in the Bundestag in proportion to the share of political parties in the national vote, so that all mainstream parties would have a voice. But to exclude disruptive fringe parties, it also required a 5 percent minimum vote threshold for parliamentary representation.

This version of representative democracy yielded stable ruling coalitions so long as voters were happy with the social and economic results and differences in the policies of centrist parties were limited. But as economic performance deteriorated and factors such as immigration fed political polarization, unhappy voters turned to parties on the extreme left and right. More parties found representation in the Bundestag. And more coalition partners with incompatible policy goals were needed to form governments.

This explains the collapse of Olaf Scholz’s three-party coalition (left-center Social Democrats, right-center Free Democrats, and lessclassifiable Greens) in late 2024, and why the extreme-right AfD and extreme-left Sahra Wagenknecht Alliance were polling as two of the top-five parties in the upcoming election.

The French Fifth Republic, established by Charles de Gaulle in 1958, was contrived to provide strong presidential leadership and an antidote to parliamentary gridlock. It assigned the president sweeping powers and mandated two-round parliamentary elections designed to yield coherent governing coalitions of center-right and center-left. Subject to parliamentary approval, the president was allowed to select a prime minister who generally did his bidding and left the National Assembly with little autonomy.

But the success of a system built on strong presidential leadership turned out to be dependent on cohesive social attitudes and electoral behavior. Groups excluded from governing circles, such as the populist yellow vests, took to the streets to defeat the president’s proposed reforms. Electorally, voters vented their dissatisfaction with high unemployment and endless economic crises by depriving presidents of majorities in the National Assembly, which effectively shifted power to prime ministers of the Assembly’s choosing. More recently, French voters abandoned the historic governing parties for new political movements – both Macron’s party of the center-right and ominously, far-right and far-left protest parties.

In the most recent legislative elections (July 2024), no party or ideological coalition came close to a majority for the first time in the history of the Fifth Republic. The far-right and far-left combined to capture more than half the seats in the National Assembly, effectively rendering France ungovernable. Despite the looming shadow of runaway deficits and a revolt of the bond markets, conservative Prime Minister Michel Barnier was ousted by a vote of no confidence against his mild austerity budget – the first successful no-confidence vote in more than 60 years.

The chickens, it seems, have come home to roost in Paris. With presidential leadership in tatters and public opinion distrustful of topdown governance, mainstream French leaders face the daunting challenge of forging policies that can deliver on both economic and fiscal reforms while somehow securing the support of the French population.

We now understand that the French system of government works adequately when the presidency is occupied by a strong figure like de Gaulle, who commands the respect of parliament and the public and delivers positive economic results. It works adequately when governments are formed by centrist parties whose programs do not differ radically from that of the directly elected president. Which is to say that it doesn’t work adequately now.

Political institutions are designed to be hard to change. Otherwise, any individual or party coming to power could immediately change them to their strategic advantage. To be sure, France has modified its constitution several times in the course of its republican history. But there’s no denying that this time around political reform will be a heavy lift.

Tale of Two Economies

The economic problems of France and Germany are both similar and different. In both, growth is anemic and adaptation to global change is incomplete. But where German infrastructure is crumbling, France has gleaming trains à grandes vitesses. The flip side is that where Germany’s debts and deficits are strikingly low, France’s are enormous, and doubts about the ability of the political system to shrink them cast a long shadow over France’s financial stability.

In both countries, the obstacles to economic reform are formidable, though of different sorts. Germany has a coherent if outdated economic model whose parts complement one another. This coherence makes it hard to reform one component of the system without also reforming the others. Piecemeal reform is thus efficiency-reducing rather than enhancing. And there has been no crisis to date of sufficient severity to prompt comprehensive reform. France, in contrast, has an incoherent system, having moved some way toward a more decentralized, market-led economy – but at the price of activating interest groups that push back against further reform, and by running dangerous financial risks.

Finally, the political systems in both countries create profound difficulties for sound economic management. The need for political as well as economic change – indeed, the need for political change to enable economic change – is clear. Easier said than done.