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Recovery in America, recession in Europe? That's what happened after Gulf War I in 1991 — and the question is again stalking the Continent. While things are looking up for the U.S. economy, in Europe unemployment is rising, capital spending by businesses remains stuck in a rut, and consumer confidence in several nations is at a 10-year low. Germany, Europe's biggest economy, may already have drifted into recession, and many economists say it could drag down the rest of Europe with it unless something unexpected happens to break the slump.

Last week, both the European Commission and the International Monetary Fund slashed their forecasts for euro-zone growth this year, to 1% and 1.1% respectively, and warned that even that paltry rate might be overoptimistic. "A worse outcome cannot be excluded," the E.U. report stated; it also predicted a "sharp" recession — two consecutive quarters of economic decline — if oil prices don't fall as much as hoped or consumer confidence fails to bounce back.

It wasn't meant to be like this. When the world economy decelerated in the weeks before the war, many policymakers and business executives attributed the slowdown to geopolitical uncertainty. For several weeks, markets seemed to react to nothing but fears of a long war or hopes for a short one. Once the war was over, the argument went, economic growth would rise as businesses stopped postponing investment decisions and consumers dipped anew into their wallets.

As if on cue, stock markets around the world rallied last week to celebrate the fall of Baghdad — but the bounce was neither high nor long. War was bad for business, but it wasn't the only problem — and peace alone won't fix all those other woes. The short- to medium-term outlook in Europe is gloomy. "The end of the war does nothing for Europe," says French economist Philippe Chalmin. "I see no reason for an upturn."

What's gone wrong? The short answer is: almost everything. In the past, exports have often fueled Europe's economic recovery from downturns. But the U.S., Japan and Europe this time are all caught in the same downdraft simultaneously. The volume of world trade has risen by less than 3% in the past two years, its weakest performance in two decades, and actually shrank in the last quarter of 2002. Moreover, the strong euro is penalizing European exporters, including such companies as automakers BMW and DaimlerChrysler.

The situation for consumers is little cheerier. House prices continue to soar by as much as 23% annually in the U.K. and Ireland, helping fuel consumer spending, but elsewhere in Europe household spending has been in the doldrums. Stock markets have been on a three-year slide that in Europe is almost as severe as that of the early 1930s. Businesses, meanwhile, have used the lull to reduce inventories, cut debt and implement rigid cost controls — but they haven't yet shown much willingness to begin investing again. Michael Hartnett, Merrill Lynch's director of European strategy, likens this corporate restructuring to cancer treatment. "This is the year of chemotherapy," he says. "You're fragile while that happens, but if you come through it, you're fitter."

Normally, a powerful external stimulus — such as a U.S. upswing, a big cut in interest rates or a continuing sharp reduction in oil prices — might be enough to kick start growth. But Europe has a deeper problem: Germany. The country has been stagnant for three years, mired in a crisis that the business community blames on structural problems such as high wages and social costs. Despite new reform promises last week from Chancellor Gerhard Schröder, Germans seem resigned to stasis. This sour mood may even be part of the problem. "There's a general dissatisfaction going around that's paralyzing society," says Helmut Gierse, president of a trade group of German companies that make factory robots and other automation equipment.

Automation is a j25 billion business for Germany, and a good window into the economic situation. Last year sales dropped by about 3%, and would have been much harder hit were it not for a big increase in orders by automakers. But that overall figure masks a sharp difference: exports, which now account for more than two-thirds of total sales, rose by almost 3%, while sales in Germany dropped by more than 10%. The bad news for the rest of Europe is that an economic upturn is much harder, and perhaps impossible, with a stagnant Germany. In his annual budget speech to Parliament last week, Chancellor Gordon Brown boasted that the British economy has outpaced most of Continental Europe in recent years. But even optimistic Brown had to cut forecasts of U.K. economic growth this year to between 2% and 2.5% from 2.5% to 3%, pinning some of the blame on the Continent's weakness.

Few are feeling the pinch as much as Ireland. Its gross national product grew by an average of almost 9% annually in the five years to 2000. But this year, the Irish central bank is forecasting gnp growth of below 2%. "The recent track record of larger euro-area economies is not encouraging," governor John Hurley said in a recent speech.

Economists' predictions are often wrong, of course, and it's possible that the worst is already over. If German consumers decided to start spending again, it could make the difference. Wolfgang Twardawa is keeping a close watch. As head of market research at the German consulting company GfK, he notes some subtle shifts in German consumer behavior. While sales of cars, furniture and clothing are all down, digital cameras and dvds are doing well, he says, joking that "Germans have a high level of whining." Still, he contends: "Something big needs to happen for the Germans to really start spending again." The problem for Germany, and Europe, is that the end of the Iraq war may not be big enough.

• PETER GUMBEL
• The end of the war won't be enough to revive Europe's economies