Germany was the economic powerhouse of Europe in the 1970s, and its continued economic success in the intervening years has contributed to rising living standards in the EU. However, its economic model is now faltering in the face of changes in the world economy.

In particular, the car industry, which played a crucial role in Germany’s economic success, has gone into decline, partly as a result of competition from China. This economic weakness was one factor influencing the election outcome in Germany last Sunday. Another big issue was tension over immigration. Since 2014, the number of foreign-born adults living in Germany has grown by more than a third.

The result was a heavy defeat for the outgoing government, and a big increase in the vote for the extreme right-wing and left-wing parties, who together captured more than one-third of the vote.

The results also showed a further continuing issue for German governments: even though unification occurred 35 years ago, politically Germany remains two countries. In former East Germany, parties of the extreme right or left got 60 per cent of the vote, while in West Germany they got 30 per cent.

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The incoming government will have to deal with these economic and social challenges, as well as with the geopolitical changes affecting Europe.

The German economy built its success on its engineering prowess, most notably in car manufacturing. From the late 1980s, the growing success of Japanese carmakers and advanced engineering was seen as a threat to both German and US competitors. However, German manufacturing adapted in the 1990s by outsourcing the less sophisticated elements of production to the lower-cost former communist countries in eastern Europe, like Poland and Hungary.

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This enabled German industry to maintain its competitiveness and continue to grow over much of the subsequent 30 years.

Things look very different today, with increased competition from China. Germany has also fallen behind in innovation in the motor industry, especially in battery technology. As a result, German factories are having to lay off workers. This loss of traditional jobs was reflected in recent voting patterns.

However, Germany continues to have big strengths in engineering that could leave it well-placed to benefit from a rise in European defence spending. But if Germany is to continue to prosper into the 2030s, it probably needs to evolve into new growth sectors.

Achieving such a switch is more difficult because Germany’s industrial strength was built on an educational system that was very good at providing young labour market entrants with advanced industry-specific skills. This worked while those industries prospered, but it poses serious problems if workers have to move to new sectors.

The German education system may need to switch from producing sector-specific skills to providing a more flexible and adaptable workforce. In particular, it will need to produce more graduates, including graduate engineers, whose training makes them inherently more adaptable.

In 1994, when the Digital computer factory in Galway closed with the loss of about 1,000 jobs, this seemed like a disaster for the country. But many of those laid off were graduate engineers, whose skills formed the basis of a new industry – medical devices. This sector has grown from strength to strength, showing the benefits of a workforce with broad skills, rather than skills specific to one industry.

While Germany’s vocational training system has produced highly skilled workers, the number of graduates it produces lags behind the EU average. The share of Germans aged 30-34 with a degree is well below that in France, Spain, Scandinavia and Ireland.

It’s even lower in the former East Germany (on a par with rates in Hungary and Bulgaria). Part of the reason there are fewer graduates as a share of the population in the former East Germany is that so many of their young population have emigrated to the West.

Unlike Ireland, which has attracted highly educated migrants, more than one–third of recent immigrants to Germany have not completed second level, and just a limited share are graduates. The resulting lower immigrant earnings potential has led to a clustering of immigrants in working-class areas that were already feeling the economic pinch. This has added to resentment.

Germany’s ageing population is another challenge for its incoming government. Over the past decade, the country’s native-born population has fallen by 6 per cent, counterbalanced by immigration.

If German election winner Friedrich Merz can find a way to upskill recent migrants and integrate them into the economy, they could potentially replace the skilled labour force coming up to retirement age. If that can be achieved, it would turn what is seen as a problem into an important resource.