Europe’s Economy Vs COVID-19: drop, but not disaster?

The coronavirus pandemic will lead to the biggest economic downturn since World War II. Already now we can talk about it with confidence. But the fall must be followed by a recovery. Speaking about it, we have less confidence. Much will depend on the course of the pandemic, the behavior of people, companies and governments.

Consequences and first-wave lessons

The COVID-19 pandemic has influenced the European economy severely, but more devastating impacts have been avoided thanks to drastic restrictive measures.

Europe's real GDP is currently projected to decrease by 7% in 2020.

Lockdowns from March to April and social distancing measures led to a drop in real GDP in Europe by about 40% in the second quarter of 2020 (quarterly on an annualized basis), three times more than during the global financial crisis.

Advanced economies experienced a much deeper decline in activity than emerging market economies, which were hit later by the pandemic and responded more quickly.

Due to strong policy meausres, the fall in employment and the rise in unemployment – ​​compared to the contraction in output – were significantly smaller than during the global financial crisis, although the full impact of the pandemic on labor markets is likely to be delayed.

However, the immediate loss of jobs and income would have been far greater had it not been for the program that subsidized wages and reduced working days.

In the euro area, employment in the second quarter of 2020 was 2.9% lower than in the second quarter of 2019, and the number of working hours fell by more than 16%.

Sectors with intensive contact (hospitality, travel and tourism) and sectors with complex value chains have been hardest hit.

Limited cross-border mobility reduced hotel occupancy to 40% by August. Countries where tourism accounts for a significant share of GDP have suffered the most. for example Croatia, Italy, Montenegro and Spain.

In the automotive sector, plant closures have led to a 27% year-on-year decline in cars in Europe in the first half of 2020 and affected almost half of directly employed workers, hitting hard in countries where the sector controls a large share of industrial production (e.g. the Czech Republic). and Slovakia).

The impact of the crisis was particularly devastating for small and medium enterprises that dominate some of the most contact-intensive sectors and provide more than half of the total production and about two thirds of employment in Europe.

In developed countries, quarantine pushed inflation towards negative values. In contrast, some large emerging market economies (Turkey and, to a lesser extent, Russia) are experiencing a resurgence in inflation as currency depreciation more than offsets the impact of weaker demand and lower commodity prices.

Inflation has picked up in all countries since June following a recovery in oil prices and demand. But inflationary expectations remained stable.

Political response: unprecedented and multifaceted

Europe's political response to the pandemic has been unprecedentedly strong and multifaceted.

Governments across Europe simultaneously rolled out large fiscal packages to support vulnerable households and businesses, eased monetary policy rate cuts, and launched unconventional responses.

Central banks across Europe have embarked on significant monetary easing. Discount rates have been significantly reduced.

Uncertainty at the start of the pandemic led to sovereign spreads widening and capital outflows from Eastern Europe, but this also quickly reversed as monetary and financial easing in reserve currency countries contained financial stress and stabilized emerging markets. Thus, exchange rates have generally returned to pre-crisis levels, with the exception of Russia and Turkey.

To protect jobs and support workers, health care spending, broad income assistance, job subsidies and increased unemployment insurance have been increased.

Several countries have expanded job retention programs by helping firms retain their workers by using public funds to pay up to 70 to 80 percent of wages for hours not worked or by providing benefits. The coverage of unemployment benefits has also been expanded.

Planned budget spending in 2020 averages 1% of GDP for job retention programs and about 0.4% of GDP for additional measures to combat unemployment.

The cost of the policy response, combined with falling revenues, will lead to a sharp increase in the budget deficit. In 2020, primary balances are estimated to fall by 9.9 percentage points of GDP in advanced economies and by 6 percentage points of GDP in Eastern Europe.

The EU has also mobilized supranational resources to fund new facilities and complement national fiscal policies.

Outlook: recovery depends on the course of the pandemic

The lifting of lockdowns has led to a significant recovery in the European economy, but has also led to a new surge in infections, increasing the risk of a second wave that could stall the recovery.

The crisis is expected to have a stronger impact on advanced economies. The countries most affected in this group are France, Italy, Portugal, San Marino, Spain and the United Kingdom, where activity is projected to decline by about 10 percent. On the other hand, Finland, Ireland, Lithuania are projected to decline by a maximum of 4%. Emerging economies are forecast to fall 4.6%.

Beyond the short-term impact, the recession is likely to leave permanent scars. Declines in investment and trade, degraded skills of the unemployed, and disruptions in global value chains will have negative long-term effects on potential growth and productivity, leading to irreversible losses in production.

Inequality is also likely to increase as workers in contact-intensive sectors tend to be poorer and more vulnerable. However, it is difficult to determine the scale of these losses at this stage, and they depend, among other things, how sustainable and effective the policy response will be and how people will cope with the virus.