Europe’s economic resilience in 2020

Europe's economic resilience in 2020

Europe’s path to recovery remains uncertain. While an economic contraction is certain for 2020, a recovery is expected to take place in 2021. Europe’s recovery is dependent on several factors, including the nature of various national crises, fiscal policies, and effective treatment of COVID-19.

An extended crisis for Europe

Main Point 1 – Europe is expected to face an extended crisis. According to International Monetary Fund’s European department director Poul M. Thomsen, an element of social distancing will prevail for as long as the pandemic persists. Combined with continued supply chain disruptions and other problems, this is prolonging an already difficult situation.

Based on updated IMF projections released in June, real GDP in the European Union is expected to contract by 9.3 percent in 2020 and then grow by 5.7 percent in 2021, returning to its 2019 level only in 2022. If an effective treatment or vaccine for COVID-19 is found, the recovery could be faster, but the opposite would hold true if there are large new waves of infection.

Some European countries will face a tougher recovery path than others. Several went into the crisis with entrenched product and labour market rigidities, holding back their growth potential. Others depend on industries that are tightly integrated into cross-border supply chains, leaving them deeply vulnerable to disruptions of such links.

In several large euro area countries, slow growth has coexisted with high public debt and limited fiscal space, constraining the ability to cushion shocks. Inescapably, sharply divergent initial conditions are likely to result in a highly uneven recovery across Europe.

Europe’s high-debt countries will bear the brunt of the social impact. For decades, several of these countries have seen their public debt burdens ratchet up in times of trouble and stabilize — but not fall — in good times. The stepwise pattern of rising debt speaks to a weak record of addressing structural deficiencies, whether due to institutional rigidity or insufficient political will.

Results have included high unemployment and emigration, especially among the youth, and a trend toward less-progressive taxation, but pensions have largely been protected. COVID-19 — a disease that calls for protection of the elderly but leaves the young shouldering much of the cost — complicates an already difficult demographic situation.

Fiscal policies for a transforming Europe

Against such backdrops, policies need to start being repositioned for a longer crisis. At the outset of the pandemic, lockdowns were a vital tool to save lives. To help economic capacity survive a short but extreme disruption and allow activity to promptly bounce back afterwards, fiscal policies were eased sharply.

Months later, fiscal support remains as vital as at the onset. But, as dislocations persist, resources will become stretched. Now is the time, therefore, to think ahead and reassess how best to use.

limited fiscal space without unduly burdening future taxpayers. The longer the slump, the greater will be the need to carefully target support for firms and households in the high-debt countries.

Change is already underway, with winners and losers. Digitalisation has emerged as a key bulwark of resilience, yet also as a divide. Across Europe and beyond, countless employees are adapting to remote work, students to remote learning, doctors and patients to telemedicine, and firms to internet-based sales and door-to-door delivery.

Countless others, however, are shut out. Many contact-intensive activities—hospitality, travel, and more — could take years to recover. Some outputs — take coal-fired power or carbon-emitting vehicles — may slip into terminal decline. Again, some countries will be hit harder than others, and inequalities could grow both across and within national borders. The new normal may not be fully envisioned, but the transition has begun.

Public funds must be used to steer the needed resource reallocation while protecting the most vulnerable. In labour and product markets, the focus should be on flexibility, including by ensuring that short-time work schemes that tie workers to their employers are kept temporary. In the corporate sector, support programs must embed incentives that encourage uptake by firms with strong business plans and discourage uptake by firms on a path to failure.

As liquidity needs become solvency needs, state aid may need to include equity injections — various European initiatives are already moving this way. Clarity on carbon pricing will also be important to set the stage for a climate-friendly recovery of private investment. Finally, public investment can and should take the lead, focusing on greening, digitalisation, and other aspects of resilience.

In conclusion, various factors will determine Europe’s recovery in the near and medium-term. Such factors include resolution of various national crises, determination and implementation of various fiscal policies, and medical treatments that addresses the COVID-19 virus.

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