Why Merkel and Sarkozy Just Can't Get Along

After weeks of fiddling while the global financial system burned, the Europeans finally got together in mid-October to support their banking systems with a coordinated €1.5 trillion bailout, in a move that may have marked the turnaround in the crisis. The various national packages of guarantees and bank recapitalization were sensible and seem to be kicking in. Money markets have begun to unfreeze. Last week buyers seemed finally to be returning to Europe's battered stock markets, with the Dow Jones Euro Stoxx index climbing 12 percent for the week. Whether this is the start of a recovery or just the segue into a next phase of the crisis is, of course, unclear. But it has exposed how the European Union works—or doesn't—and the fissures between two of its biggest members.

For all of European leaders' assertions that this is "Europe's moment"—both French President Nicolas Sarkozy and German Chancellor Angela Merkel see the crisis as a vindication of Europe's more "social," less market-driven economic models—they've been deeply at odds over how exactly that moment of glory should be seized. Just as important, they can't seem to decide who should seize it. As a result, the upheaval in the global balance of economic power finds Europe once again looking inward, busy with its internal divisions. Hardly a day seems to pass in which Sarkozy, who currently holds the rotating EU presidency, announces a bold new plan, only to find himself rejected by Berlin.

The dispute is as much over style—Sarkozy tends to shoot from the hip without consulting EU partners, while Merkel prefers to first tie the strings together behind the scenes—as it is over substance. Whether it's Sarkozy's plan for a Europewide scheme to part-nationalize "strategic" companies or his proposal to create a central "economic government" for the 15 countries using the euro (with himself at the head through the end of next year), the Germans have been vehemently opposed. Merkel's economics minister and political ally Michael Glos says the French proposal to buy up companies, for example, "contradicts every successful principle of our economic policy"—announcing in public what Merkel is known to say in private.

It's hard to overestimate the disdain and distrust between Paris and Berlin. At the root is French industrial policy, where the Germans have watched in horror as Paris has managed, case after case, to assert French control over what the Germans thought were joint projects, while at the same time shutting German companies out of the French market. Based on those experiences, the Germans suspect Sarkozy's plan to partially nationalize French industry is in reality aimed at rolling back European single-market rules and further shut the French market to European companies and competition. "The Germans feel cheated, lied to and done in by the French nationalist industrial policy," says John Kornblum, a former U.S. am-bassador who now advises Lazard. The French, in turn, accuse the Germans of ignoring the gathering crisis and staying passively on the sidelines, instead of offering counterproposals of their own.

The Germans are joined in their skepticism of French protectionism by much of Europe: not a single EU member came out in support of Sarkozy's plan to amass ownership stakes in "strategic" industries. "We need a big country like Germany to stand up to France," says Ann Mettler, director of the Lisbon Council, a Brussels think tank. "If it's Germany that vetoes a return to protectionism and old-style state interventionism, then that's a very, very important victory for economic rationality." A renaissance of old French-style interventionism, she says, will cut Europe's competitiveness and growth. Already Europe's economy is expected to shrink by 1 percent next year. That's also why Merkel, who believes that protectionism would be the worst response to the crisis, has been pushing to restart trade talks.

The stalemate between Sarkozy and Merkel has also left an opening for others—most notably British Prime Minister Gordon Brown—to inject fresh ideas into the debate. It's hard to remember a time when Britain has been as proactively involved in EU economic policy. The bailout plan eventually copied by much of Europe was a British blueprint. The other big surprise emerging from Europe's divisions is how small a role the structures so venerated by Europe's multilateralists—the EU or even the International Monetary Fund—have played in coordinating a response to the crisis. Instead, Europe's leaders consulted directly with each other, creating a financial coalition of the willing. Last week a personal meeting between Sarkozy and Brown sparked a public call for China and the rich Gulf oil states to help shore up emerging-market economies with a part of their reserves. If it helps leaders such as Brown get creative—and spare Europe a return to the blanket interventionism that has paralyzed its economy in the past— then the collapse of the Franco-German motor may not be such a bad thing.