As presented in the introduction to this section, although Germany’s machineryindustry suffered from serious decline in the early 1990s, it still has a larger share ofworld trade than the other countries we examine. The aim of this chapter is toanalyse the preconditions for the recovery which lay behind this relative success,with special reference to the machine-tool industry around Stuttgart in Baden-Württemberg. To assert that Stuttgart’s specialized machine tool firms were able tomaintain comparative advantages may sound provocative to authors who haveargued that these advantages (including their wider infrastructure such as thetraining system (Kern and Sabel 1994)) turned into disadvantages during the years ofcrisis. But our analysis is not primarily designed to explain the overall performanceof this sector; it depicts how the local economy recovered in relative terms. Manyniches have certainly been lost to foreign competitors, leading to decliningemployment and turnover (Kerst and Steffensen 1995; Lippert 1999).Using the governance approach we therefore analyse the external challenges tothe local economy in the 1980s and 1990s and show how firms and supportinginstitutions adopted new strategies.As we discussed in the previous volume (Glassmann and Voelzkow 2001),LCCGs for territorially anchored production systems in Germany are providedaccording to two basic forms of public governance: federalism and corporatism. Wealso highlighted the relevance of vertical relationships between large and smallfirms, and the relatively large size of German SMEs with their correspondingcapability for in-house production of LCCGs and their low acceptance of communitybased (horizontal) cooperation. In this chapter we shall show how localrecombinations of governance modes within a national governance framework canoccur as a result of temporal, sectoral and regional variations, still assuming that forGerman firms clustering is not as important as it is for firms in some other countries(Lau 1997). However, there do remain distinct benefits from local clustering, and weshall consider these below.We shall first examine the historical origins of the machinery industry inStuttgart to discover the structural path-dependence of the production system.Second, we shall depict the development of the Diversified Quality Productionregime (DQP) in Germany after World War II and the role of Stuttgart’s firms and