Economic Impact of COVID-19 on EU: From Frying Pan into Fire

Written by | Monday, April 27th, 2020

For the time being, the health impact of the COVID-19 pandemic will, for obvious reasons related to the devastating effects of the virus, continue to be at the forefront of public policy. However, the concerns over its economic impact are already omnipresent, too. One of the great uncertainties of this crisis is the nature of its long-term economic impact. It will most certainly be bad, and almost certainly be worse than the financial and economic crisis of a decade ago, with many referring to the Great Depression of the 1930s. The International Monetary Fund’s current GDP forecast for annual growth in advanced economies in 2020 is a contraction of more than 6%.1 This might need to be revised downward as it does not fully capture the economic shock experienced everywhere. The economic repercussions of COVID-19 will be felt for quite some time; most certainly in 2021, which is looking to be a very difficult year, but most probably even beyond that.

The period of enforced economic inactivity in large parts of the EU economy not only impacts revenues, income and employment in the short term but also affects the long-term sustainability of many businesses. For example, many will accumulate debt during the lockdown. Clearly, government policy will mitigate some of this impact, especially in the short term. However, there will inevitably be limits that are also dependent on the length of this inactivity period. The uncertainty is even greater regarding the period following the gradual exit from the lockdown. The shape of the recovery to hopefully come is indefinite and very dependent on the nature of government intervention. Some countries will be able to cushion the negative trends much more effectively than others, which will increase divergence further.

Uncertainty matters, not only at the individual and corporate levels but also for the design of policy interventions. What instruments will best amplify the expected bounce back at the end of the lockdown? How can we deal with the geographically different trajectories of this health crisis, which will impact on economic recovery, taking into account country-specific economic vulnerabilities? How do we best adapt to (widely anticipated) permanent shifts in demand between different activities and sectors? How will international and European supply chains be affected? How will the EU’s long-term policy trajectory towards the Green Deal be affected by the significant cash injections required to address the immediate crisis impacts now? Which orthodoxies will need to be jettisoned, and which ones promoted, to address the systemic nature of this crisis? The answers to these questions depend on a better understanding of what is happening and what will come next. A close analysis of the onset of this crisis and lessons from previous recessions helps us provide sound predictions of future economic impacts, which is summarized in the following ten key takeaways:

1) It is highly uncertain how the economic crisis that is already hitting the global economy will continue to develop. This matters both in terms of developing a strategy, including an exit strategy from the current period of lockdown; and for policymaking, resulting in greater uncertainty about the effectiveness of potential crisis responses.

2) This crisis will likely be very different from previous economic downturns. There will be at least two phases: a period of lockdown, followed by a rebound; and the subsequent, longer-term recession or even depression. Policies must be targeted to deal with these distinct phases.

3) During the lockdown, it is necessary to provide bridging support to companies and individuals, to enable economic survival until restrictions can be gradually lifted. This will limit the accumulation of liabilities that hinder a reactivation of activities. For the subsequent recession, a continuous stimulus will be needed to foster and sustain recovery.

4) The possibility of a second wave of the pandemic in any territory cannot be excluded. Its likelihood will be increased if restrictions are loosened prematurely, amplifying the negative impact. A precautionary approach thus minimises the potential impact on not only health but also the economy.

5) There will not be a return to the pre-crisis economic environment. There will be structural shifts and permanent changes to levels of demand for particular goods and services. Policies will need to be adjusted to ensure that jobs and economic activity which will not restart post-crisis are not maintained indefinitely. Governments will need to manage permanent reductions in demand.

6) The economic impact of the crisis will vary, depending on different trajectories of the crisis as well as specific vulnerabilities and capacities of governments. Those regions and/or countries able to reopen early on are likely to have an advantage, regaining and, at times, overtaking others in the market.

7) Government action, including coordination across borders and of learning and feedback, will matter. Governments will also be much more involved in many parts of the economy. However, the capacities of governments will also be more limited, given increased levels of debt and the need to support many parts of the economy in the long term. The capacity to act also differs between governments.

8) Global and European interdependence will persist in the post-crisis environment. But European and international supply chains will potentially be disrupted and, at times, permanently altered in the aftermath of the pandemic. To be able to maintain Europe’s current living standards in a more restrictive global environment, reliance on each other, including the Single Market, will be crucial.

9) The world’s approach to economic development will alter. In some countries, the crisis will generate an impetus towards a more sustainable and socially just society. However, many governments will be tempted to focus on jobs and growth solely, regardless of distributional or environmental impacts. The delineation between the public and private sectors will also become increasingly blurry and approaches to macroeconomic management, monetary policy and the financial sector are likely to change in the post-pandemic phase.

10) The only effective instrument that has been created to deal with cross-border challenges like this pandemic and its aftermath is the European Union. However, it crucially depends on whether Europe will deliver collectively. This will require fast and decisive action, including unconditional and effective solidarity. Old divisions should not be allowed to stand in the way of an effective crisis response.

The key lesson is that at a time when many instincts point to a greater focus on the national level and greater sovereignty and self-reliance, the best answer lies in greater cooperation, at the very least at the European level.

‚The Economic Impact of COVID-19 on the EU: From the Frying Pan into the Fire‘ – Discussion Paper by Fabian Zuleeg – European Policy Centre / EPC.

The Discussion Paper can be downloaded here

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