The current recovery of the German economy has so far been weaker than in previous upswings, putting into question the conventional notion that a strong increase in external demand will translate into a sustained recovery of domestic demand. Private consumption and capital formation, in particular, have been unsatisfactory in recent years.

This Country Focus argues that it is mainly the latter which is at the root of Germany’s economic problems. There is a large negative investment gap in machinery and equipment, indicating substantial scope for catching up. However the weakness of investment in this sector can at least in part be explained by cyclical factors. Moreover construction investment is still undergoing a painful structural adjustment following the build-up of over-capacity after unification. But lifting investment is the key to pulling Germany out of its low-growth trap, and recent indicators suggest that reforms undertaken in the last few years may now at last be making an impact.

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