Box B
The pandemic’s impact on GDP: A historical perspective
The extent of the expected economic decline in 2020-2021 rivals the steep drop in activity that followed the global financial crisis. It is therefore worth comparing the intensity of the ongoing economic crisis to the global financial crisis, which could provide insight into the likeliest paths to recovery. To this end, this analysis compares the expected decline in GDP in 2020-2021 (defined as the COVID-19 recession) with the worst two-year cumulative losses in GDP and with the global financial crisis for individual countries. One obvious caveat is that the 2020 and 2021 forecasts might turn out to be quite different from the actual data given the high uncertainty surrounding the recovery.
Figure B.1
Cumulative two-year contractions – comparison with the global financial crisis
Source: Penn World Table, Eurostat, IMF and EIB staff calculations.
Note: GDP forecasts for 2020 and 2021 are based on the European Commission’s July 2020 forecast and the IMF’s June 2020 WEO update (IMF, 2020b). For almost all advanced economies, the starting year of the analysis is 1950. However, for some countries, data only becomes available as late as 1990 (such as for many Central and Eastern European countries).
The global financial crisis is identified as the worst crisis in post-World War II history for many countries in Western and Northern Europe (Figure B.1). In Southern Europe, it sits close to the COVID-19 crisis. The expectations of a rebound in 2021 make COVID-19 a relatively short-lived recession. This latter forecast is also based on the assumption that the health crisis will be resolved in 2021.
Figure B.2 illustrates the comparison from a different angle. The vertical axis shows the percentage of two-year cumulative decline and the percentage of those contractions that are worse than the 2020-2021 result for the total sample. In general, the figure depicts the well-known fact that mature economies are more stable and less susceptible to frequent declines in output. For nine countries, all two-year periods of contraction were harsher than the 2020-2021 crisis. The countries of Central and Eastern Europe experienced dramatic losses after the fall of Communism with the entire economic system wiped out, which explains why for most of them the decline in 2020-2021 is smaller than previous declines. For Southern European countries, however, the decline from the pandemic stands out as one of the harshest contractions since World War II.
Figure B.2
Frequency of contractions and worse-than-2020 contractions (in %)
Source: Penn World Table, Eurostat, IMF and EIB staff calculations.
Note: GDP forecasts for 2020 and 2021 are based on the European Commission’s July 2020 Forecast and the IMF’s June 2020 WEO update (IMF, 2020b). For almost all advanced economies, the starting year of the analysis is 1950. However, for some countries data availability starts as late as 1990 (such as for many Central and Eastern Europe countries). The green bar shows the number of contractions that are bigger than the 2020-2021 decline as percentage of all years in the sample. When the two bars are equal, all contractions until 2020-2021 have been worse than the current contraction.
Aggressive policy measures soften the blow of unemployment across the European Union
Labour productivity, measured as GDP per hour worked, slightly increased in the second quarter of 2020, in contrast to a large decline in GDP per employee. While the cyclical nature of labour productivity is an empirical fact, the significant difference between the change in GDP per employee and that of GDP per hour worked is unusual. In the second quarter of 2020, EU GDP per hour increased by 0.3% relative to the same period of 2019, whereas GDP per employee fell 11.5%. A difference of this scale was not seen even at the peak of the recession following the global financial crisis. In 2009, for instance, EU GDP per hour fell 1.2%, while GDP per employee declined by 2.6%. The difference in 2020 indicates the extent of the employment subsidies that most EU governments made available to businesses in the second quarter of 2020.
Massive government support kept the increase in unemployment relatively contained at the end of the third quarter of 2020 (Figure 13). The unemployment rate rose by about 0.5 percentage points in Western and Northern Europe and Central and Eastern Europe (Figure 13a). The increase was higher in Southern Europe (1.5 percentage points). The United States saw an increase of 4 percentage points over the same period with a peak of 10 percentage points in April. The difference between the two sides of the Atlantic can be mostly explained by significant differences in labour-market institutions and also by substantial government financing of policies to retain labour (Box D). The effect of government measures can also be indirectly gauged by comparing the contained increase in unemployment with the steep decline in total hours worked across the European Union (Figure 13b). This suggests that if employment was not subsidised, the increase in unemployment would have been much greater (Box D for caveats).
Figure 13
Unemployment and total hours worked
Source: Eurostat and EIB staff calculations.
Increasing risks of a slow recovery and a substantial increase in government indebtedness do not bode well for the unemployment outlook in the near term. General government debt in the European Union increased by 8.5 percentage points of GDP to 88% from the first to second quarter of 2020 as the pandemic intensified. The sharp increase in debt is likely to curb governments’ ability to act as decisively should the pandemic’s second wave require further restrictions in the fourth quarter of 2020 or first quarter of 2021. With a stalled recovery and, possibly, a weaker fiscal response, unemployment is bound to increase significantly. Higher unemployment will exert additional pressure on social protection systems to extend their remit to parts of the population not covered by current programmes (Box C).
Box C
Social protection systems and the COVID-19 shock: Adapting short- and long-term support
Social protection systems play a central role as stabilisers when economic shocks occur. Unemployment benefits are clearly countercyclical but other forms of social spending such as pensions or sickness benefits also contribute to maintaining households’ disposable income in times of economic stress. Structurally, social protection systems help to reduce the incidence and depth of poverty, improve the health of the population and facilitate access to education.
The stabilising effects of social protection systems are stronger in higher-income countries due to the size and composition of spending. EU Member States with higher incomes spend relatively more on social protection and typically place greater emphasis on sickness, family and unemployment benefits (European Commission, 2019). Following the global financial crisis, social protection expenditure increased, reflecting in particular the higher spending on unemployment benefits following the shock to the economy.
The pandemic prompted unprecedented policy action