Investment has weakened dramatically around Europe since the financial crisis erupted in 2008. Governments have been scaling back their public capital programmes in order to restrain fiscal deficits, while the private sector has responded to weak demand through a reduction in capital budgets.

Tight bank credit has also been a factor and some private sector businesses simply see no prospect of larger capital outlays given their already stretched balance sheets.

As a result, capital formation in Ireland has fallen to about 12% of GDP, less than half the ratio of a decade ago. The fall is partly explained by the collapse in house building, which is inevitable given the over-investment in residential property during the bubble.

But the fall in business capital investment is more worrying from a long-term standpoint. A growing economy should have a ratio of investment to GDP of at least 20%, and Ireland has been well below this figure for several years now.

Low interest rates at eurozone level will not induce private investment where businesses feel they already have adequate capacity and the constraints on domestic demand place the majority of firms in precisely that position: there is no point in building an extra plant if it is likely to lie idle.

But many firms are not oriented solely towards the domestic market. The recent Central Bank survey of SME (small and medium enterprises) lending shows that access to credit for smaller firms in Ireland is more difficult than is the case in core eurozone countries.

It also documents a “ discouraged borrower” effect – firms do not even apply for loans, in the expectation that they will be refused. The position in Ireland and in Greece is the worst in this regard.

Ensuring an adequate supply of credit for expanding firms, which will equate to firms in exporting sectors so long as domestic demand remains weak, should be a policy priority.

The essence of the supposed European monetary union was that access and cost of credit would be equalised for all firms in countries that joined the single currency. The reason this has not happened is called “financial fragmentation”, a fancy phrase which describes a situation in which the playing field has been tilted against firms in the eurozone periphery, which either cannot access credit or face extra interest costs whenever they can.

In a free-trading zone with a single currency and unrestricted capital flows, this was not meant to happen.

The causes of fragmentation are clear enough. The banks on the periphery have become less credit-worthy and have passed along the consequences to their captive SME customers. Bigger firms can access international banking and bond markets directly, but the smaller firms are stuck with their local banking systems.

Since the eurozone did not create a proper banking union from the start and still has not done so, fragmentation represents a further handicap on recovery in the periphery. Firms have got screwed twice. Domestic demand is weak and likely to stay weak for some time, but even the smaller firms that might export successfully are denied fair access to credit.

The ultimate solution is the completion of Europe’s monetary union, which would mean a centralised rather than a national system for running banks, a banking union such as that which exists in the United States.

Just because the state finances of California get into trouble, it does not mean that expanding firms in California are denied credit from the banks, or are charged extra whenever they can get it.

There is no link in the US system between the credit-worthiness of state governments and the firms which happen to be located in those states. The failure thus far to break the link between insolvent states and their banking systems lies at the heart of the SME credit problem on the eurozone periphery, Ireland included.

Since this is a problem deriving from the design flaws in the common currency, there are limits to what the Irish authorities can do about it. There has been a recent initiative called the Strategic Banking Corporation of Ireland. This will use State money and assistance from the German KfW bank to make additional loan finance, and possibly equity, available to the SME sector. Whether this new institution will deliver the goods remains to be seen.

At European level, the imperative is to re-capitalise the banking system, particularly on the periphery, to whatever degree is needed to unblock credit channels.

Since peripheral governments are in a weak position to address this issue, some initiative at eurozone level is required. Stress tests and assessments of capital adequacy for 228 European banks are currently under way and due to be completed in the autumn. They should be followed by a re-capitalisation, with common funds if needs be, designed to end the fragmentation of corporate credit markets.