The big surprise out of the European Union summit meeting last week was not its acrimonious collapse over farm subsidies and equalization payments. More surprising was that after years of declaring that the urgent challenge facing Europe was to rely more on free markets to grow the economic pie, the E.U.'s leaders remain fixated on questions of how government should divide it up.

The widespread view here is that the 50-year-old European project has been seriously derailed. In the wake of failed referendums in France and the Netherlands, a new constitution has been put on ice, along with further expansion to the east and a proposal to allow services to be traded across borders as freely as goods. The euro not only has failed to spur the hoped-for cross-border consolidation but has proved to be a barrier to the effective use of monetary and fiscal policy in a trading bloc where growth and inflation rates vary widely from one country to another. Italy is in recession and Germany is barely treading water, while unemployment in France is back in double digits. For all intents and purpose, the governments of all three countries have fallen.

"People will tell you Europe is not in a crisis," declared Jean-Claude Juncker, the prime minister of Luxembourg. "It is in deep crisis."

Much of this crisis stems from the dread that continental Europeans have of globalization and market liberalization, and from a refusal to embrace the essential truth of capitalism -- namely that the way it generates growth is through a messy and disruptive process of shifting jobs and capital from existing companies and industries to more productive ones. Whenever this reality runs into the natural instincts of a prosperous people to maintain the status quo, the instinct of European leaders has been to retreat into comfortable old socialist nostrums.

Here in the industrial heartland of Germany, this recently took the form of political attacks against U.S. and British private equity funds that have been actively buying control of ailing corporations and investing in mid-size, family-owned companies that have always been the backbone of the German economy. The monthly magazine of the country's largest union recently featured a cover story that portrayed the foreign investors as bloodsuckers, while the head of the local Social Democratic Party called them locusts and prepared a blacklist that somehow made its way into the press.

The irony, of course, is that the only reason these private equity firms have been so active here is that Germans themselves have been reluctant to invest. German banks are saddled with so many bad business loans that they have been pulling back, while German financial markets have shown little enthusiasm for stock and bond offerings except from the largest firms. Despite record profits, German companies last year cut their domestic investment by 20 percent, according to Handelsblatt, the business daily. German households, meanwhile, have reportedly stashed as much as $500 billion of their savings in Switzerland and other tax havens, where it does little good for the back-home economy.

Those dreaded foreign investors, meanwhile, have made good money unlocking the hidden value in German firms. London's Permira, for example, rescued the pay TV operations of the bankrupt Kirch empire and in short order fixed it up and brought it public last year, bigger and more profitable than ever. Goldman Sachs and KKR did the same with Wincor Nixdorf, the once-floundering software and service division of Siemens, where some 3,000 jobs have been added.

The problem for many Germans, like many other Europeans, is that while they would love to capture the good things that come from this kind of free-wheeling capitalism -- the job growth and the increased competitiveness -- they want them without the disruption and insecurity and income inequality that are also part of the package. Their hope has been to find a way to preserve a "social market" model that worked so well for them during the rapid growth and hyper-investment of the postwar years. But today, with the inescapable challenges posed by global competition, slower growth and unfavorable demographics, the "social market" boils down to not much more than protecting existing jobs, existing companies and existing lifestyles in ways that sap an economy of its creative dynamism.

So far, attempts to reform have been a two-steps-forward, one-step-back process that has generated some pain but not much gain. The anxiety and disenchantment has already led to the ouster of German Chancellor Gerhard Schroeder's Social Democratic Party from its generation-long control of the state government here in North Rhine-Westphalia and forced Schroeder to call for early national elections this September. But if Schroeder loses that election, as many here think he will, it is not clear whether the more market-oriented Christian Democratic Union will have any better luck pushing through its program.

Up to now, politicians of both parties have presented those reforms in negative terms, as concessions, or sacrifices, or accommodations necessary to hold onto the good life that most Germans now enjoy. But economists, business executives and politicians were unanimous that any new government will have to frame the proposition in a much more positive light, explaining that the willingness to take risks and work harder won't just let Germans keep what they have, but also allow them to get their economic mojo back and become more prosperous than ever.

That kind of attitudinal breakthrough won't come easy. It requires overcoming an education system which explicitly teaches that capitalism is harsh and unjust, and a national media that delights in stoking class resentment and economic pessimism. Most Germans are well past the point of knowing that something big has to change. What they don't have is faith in either their leaders or the free-market dynamic to ensure that things can get better.

Luxembourg Prime Minister Jean-Claude Juncker, shown at an E.U. summit last week, said Europe "is in a deep crisis."