Europe’s COVID-19 Crisis Response: A Race Well Run, But Not Yet Won

Forum DOI: 10.1007/s10272-021-0981-x Alfred Kammer and Nathaniel Arnold Europe’s COVID-19 Crisis Response: A Race Well Run, But Not Yet Won A laudable response to the pandemic The COVD-19 crisis has been the biggest global economic shock since World War II. Unlike the “global” financial crisis – which was really a US and European financial crisis that spilled over to the rest of the world – the pandemic was truly an exogenous global shock. Many countries reacted quickly with mobility restrictions and lockdowns as the pandemic swept across the globe in early 2020. These initial containment measures dealt a blow to the incomes of businesses and workers across the economy, though the intensity of the impact differed across sectors – with tourism and hospitality clearly suffering more and being less able to adapt. Moreover, the shock was severe but expected to be temporary due to the success of activity restrictions on reducing new COVID-19 cases in the first wave of the pandemic, as well as rapid development of vaccine candidates. Governments, especially in advanced economies, countered the COVID-19 crisis with unprecedented levels of policy support. In Europe, policies aimed at preventing the unnecessary destruction of businesses and jobs and maintaining the structure of the economy in the face of a temporary exogenous shock. And the policy response so far – at both the national and European levels – has been incredibly successful. The monetary and financial regulatory policy response helped prevent financial markets from seizing up as the pandemic struck. It kept credit – the lifeblood of the economy – flowing, with lending growth to firms jumping from 2.5% in February 2020 to over 6.5% in May in the euro area. © The Author(s) 2021. Open Access: This article is distributed under the terms of the Creative Commons Attribution 4.0 International License (https://creativecommons.org/licenses/by/4.0/). Open Access funding provided by ZBW – Leibniz Information Centre for Economics. Alfred Kammer, International Monetary Fund, Washington DC, USA. Nathaniel Arnold, International Monetary Fund, Washington DC, USA. 194 At the same time, fiscal support for workers and businesses helped prevent a massive rise in unemployment and a cascade of bankruptcies. This has – to a large extent – preserved the fabric and structure of the economy in the face of massive uncertainty. These policies helped keep household disposable income in the euro area from declining between 2019 and 2020, despite a 6.6% drop in real GDP. The public sector stepped up to shoulder the burden of the shock and tried to make households and businesses whole – a task made easier by the strength of the existing social safety nets in Europe, which were able to be quickly expanded where needed to meet the challenges of the COVID-19 crisis. For instance, job retention schemes were a critical part of the response. These schemes pay part of an employee’s normal wages if a business keeps them employed but reduces their hours. In this way, businesses can temporarily reduce labour costs in the face of weaker demand without laying off workers. At the same time, workers’ incomes are maintained even if the working hours are reduced. Moreover, by maintaining the worker-job bond, job-specific human capital is preserved and long-lasting economic scarring due to the loss of human capital is reduced. Many EU countries had job retention schemes in place already and expanded them during the crisis to cover a broader range of workers (e.g. gig workers), while others were able to quickly add such programmes to their social safety nets. On average, EU countries are estimated to have spent nearly 2% of GDP on job retention schemes in 2020. The benefits of such schemes are readily apparent from the unemployment numbers. While hours worked in the second quarter of 2020 fell more than 15% below late-2019 levels in the EU, the employment rate fell less than two percentage points and the unemployment rate ticked up one percentage point. These job retention schemes were supported at the EU level with €100 billion in low-cost loans to countries. In contrast, the US, which did not have job retention schemes in place, saw a sharp spike in the unemployment rate in the second quarter of 2020, going from 4.4% to 14.8% between March and April, before steadily declining. As a result, the annual average unemployment rate in the US more than doubled in 2020, necessitating higher spending on unemployment benefits, which was similar to the average amount spent in EU countries on job retention schemes. Intereconomics 2021 | 4 Forum European countries also announced an array of measures to support businesses, including “above-the-line” measures like tax cuts, as well as “below-the-line” measures like equity support, loans and loan guarantees. For the latter, euro area countries announced programmes worth 17% of GDP in 2020. Even though the eventual take up of these programmes only amounted to about 5% of GDP, these measures played an important role in shoring up confidence and convincing banks, which entered the crisis in a strong position, to continue lending in the face of a sharp drop in economic activity. Despite the large fiscal response, Europe on average suffered a greater drop in real GDP than the US did. While comparisons between fiscal responses in the US and the EU are not straightforward, taking into account the more robust social safety nets in EU countries and “below-theline” measures, they provided comparable degrees of fiscal support in 2020. The pandemic had a larger growth impact on many European countries, but this was mainly due to factors besides the fiscal response. These factors include different initial underlying growth rates, the structure of the economy – with many of the hardest hit European countries more dependent on sectors most impacted by the pandemic like tourism – the severity of activity restrictions and the ability to adapt to the pandemic, such as through teleworking. A robust transition to the post-pandemic world Now, with vaccine rollouts accelerating, the prospects for a return to something approximating normalcy look good. But the economy will not just snap back to its prepandemic form. There will be shifts in the structure of the economy, partly driven by deeper technological and environmental changes. Moreover, achieving a greener, more digital and inclusive economy will require transformations in many sectors. Policies must help facilitate these transformations. Labour and product markets in the EU are generally more rigid than those in the US, and European firms lack access to venture capital and other forms of financing that many US firms enjoy. These shortcomings will inhibit the capacity of European economies to respond to the shifts in the economic landscape occasioned by the pandemic and coming economic transformations. Less flexible labour markets can hinder the flow of workers from declining firms and sectors to new and (...truncated)