The European Commission has just issued its Spring forecast. As expected, the pandemic is taking an unprecedented toll on the area’s growth: the European Union faces the deepest economic recession in its history and its full effects, immediate but most likely also permanent, are still largely unknown.
Provided the pandemic remains controlled and that the necessary containment measures adopted are gradually lifted, the Commission is expecting activity to start recovering in the second half of the year. Not the best scenario. But also, not the worst, since the risks to the forecast are exceptionally large and tilted to the downside, given that the pandemic could become more severe and last longer than assumed, with the possibility of a second wave of infections in the fall still open. However, if the Commission is right, the EU will recover only partially in 2021, leaving the Union’s output about 1.8% below its 2019 level.
The Covid-19 shock is hitting all Member States, but its economic impact is expected to be largely asymmetric among them. Looking at the Commission’s forecast -which does not depart much from that of other international institutions that have already ventured their opinion-, the economies that will be affected the most, find themselves, mainly, in the southern part of the Union. But this, too, has its exceptions. Let us look at the expected GDP declines and rebounds.
The Commission is forecasting that the European Union’s GDP will contract a 7.4% in 2020 and rebound by only a 6.1% in 2021. 7 out of 27 EU Member States will see their output contract above that figure and only 5 will register an output decline above 8%: Greece (-9.7%), Italy (-9.5%), Spain (-9.4%), Croatia (-9.1%) and France (-8.2%). Accordingly, the rebound in those five countries will be forceful and above the EU’s average. But, especially in Italy, Spain, and Greece, this rebound will be far from enough to compensate for the higher loss of output. As a result, in those three countries, their output in 2021 will be around 3% below its 2019 level: Italy (-3.6%), Spain (-3.1%) and Greece (-2.6%), while France will recover much more (-1.4%).
But there are other countries worth mentioning as they could be exceptions to these figures. On one hand, Finland, which will have a milder recession (-6.3%) but also a more subtle recovery (3.7%); Finland’s 2021 output is forecasted to be a -2.8% below its 2019 level, a similar loss of that of the above-mentioned Southern countries. On the other hand, Portugal, a Southern economy, will experience a more moderate output decline than its fellow countries which, together with the expected rebound, will place its 2021 output only a -1.4% below its 2019 level.
What is behind this asymmetric impact? Are there any common elements that explain the stronger economic effect of the pandemic in these Southern economies? Why does Portugal seem to be an outlier?
At this stage, one could identify, at least, three country specific factors that would offer an explanation to these differences.
The first one is the extend and timing of the pandemic which is reflected in the reported number of Covid-19 infections and deaths and which has largely determined the intensity of the lockdown, both in duration and strictness of the measures. Italy, Spain, France, and Belgium, together the UK, are among the most affected countries in the world and, also, among those who have implemented the most severe lockdowns, especially Spain and Italy and, to a lesser extend France. As a result, all of them will experience dramatic GDP falls in 2020. Greece and Portugal, with far fewer cases, have also implemented important lockdowns, but, for specific reasons, acted earlier on in the epidemic.
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The second factor refers to the country’s economic structure and to its exposure to the external environment. The rebound in all economies will be gradual and uneven across sectors. Open economies with a large international exposure to those sectors more sensible to disruptions in the free movement of people (ie. the hospitality, tourism, and travel sectors) and with a high share of small or very small businesses are particularly vulnerable in this crisis. Indeed, travel and tourism where the first sectors hit and, probably, will be the last ones able to resume their activities. And even when restrictions have been lifted, demand will not recover rapidly, since confidence, uncertainty and the, at least temporary, drop in disposable income will refrain consumers from travelling for some time.
All this explains the significant impact of the pandemic in countries such as Greece (whose tourism receipts are, additionally, heavily concentrated in the summer months), Spain, Italy, France, or Portugal. It also determines an uneven recovery across sectors and important risks to the outlook in these economies, very dependent on small changes in the development of the pandemic.
The third factor relates to the countries’ fiscal response. Fiscal space is needed, first, to fight the virus and limit the number of infections and casualties; second, to mitigate the economic impact on income, revenues and liquidity and, thus, protect the economic tissue and employments so that the activity can resume once restrictions are lifted; and, third, to provide support to the recovery. But it turns out that some of the Member States hit hardest by the virus are those with the least available fiscal space to respond. Such is the case of Italy and Grece –with a very high level of gross public debt – and of Spain and France– with high levels of public deficit. Portugal, on the contrary, entered the crisis with a slight superavit and structural balance.
Apart from these factors, there are others that could explain some of the differences. Spain and Greece entered the crisis with high unemployment rates that will rise substantially to levels around 19% in 2020, amplifying the shock to the economy. In the whole EU, investment will be severely hit in 2020, as many businesses are experiencing several shocks and are faced with uncertainty and financial constraints. The Commission expects gross fixed capital formation to fall more significantly in Spain, Greece, and Portugal but these two last countries will almost fully recover it in 2021, whereas Spain will only do it partially. Portugal has been able to provide significant fiscal support, helping contain the impact of the pandemic, but its outlook is subject to risks, partly due to its important economic links with Spain.
In conclusion, most of the Southern EU economies are forecasted to be more affected by Covid-19 by a number of factors. However, we should bear in mind that all EU economies have strong interdependencies, in terms of movement of people, intra-EU value chains or financial sectors. Therefore, an incomplete recovery in one country would spill over to all the rest, affecting growth everywhere.
Given that the country’s economic structure cannot be changed in the short term, the differences in fiscal space among Member States will be key to shape each country’s recovery and the amount of support it can gives to its economic tissue. But it could create permanent divergences across countries and distort the internal market which is at the core of the EU integration success and welfare and the basis of the Monetary Union.
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