the precipitous decline is most likely due to these severe restrictions. The drop in investment in EU countries in the second quarter is clearly associated with the governmental or self-imposed curbs on movement (Figure 4). This kind of restriction explains, in particular, the varying declines in investment in buildings and structures across the different countries, as shown in Figure 3.[4, 5] The restrictions on movement were lifted at the end of the second quarter and the beginning of third quarter. GDP showed a partial rebound in third quarter, so we can expect some of the decline in investment to be reversed in that quarter. That said, the recovery might prove to be unimpressive as two very important factors determining investment decisions gain prominence – uncertainty and the impact of corporate liquidity and net worth.
Elevated uncertainty has a powerful negative effect on investment that is widely documented in the academic literature (Leahy and Whited, 1996; Guiso and Parisi, 1999; Butzen, Fuss, and Vermeulen, 2003; Bloom, Bond, and van Reenen, 2007). As fixed assets are generally more difficult to liquidate, firms are reluctant to invest in this area during periods of elevated uncertainty because their sensitivity to demand shocks would increase as a result. The tendency to postpone this type of spending when uncertainty is high reduces the effectiveness of policies aimed at stimulating investment, and more aggressive policy actions are required. (Bloom, Bond, and van Reenen, 2007; Bloom, 2014).
While uncertainty seems to have partially subsided after the initial shock in March 2020, it is still elevated and is likely to remain so for some time (Figure 5). Early evidence suggests that higher uncertainty is taking a toll on business investment (Figure 6). The share of respondents in the EIBIS 2020 that say uncertainty is a major obstacle to investment explains about one-sixth of the decline in total investment in the first half of 2020. Similarly, differences in respondents’ views about their business prospects, which is arguably another measure of uncertainty, explains around 13% of the variation in aggregate investment across countries.
Figure 4
Real GFCF and COVID-19 containment measures
Source: EIB staff calculations based on data from Eurostat, OECD national accounts, Oxford COVID-19 Government Response Tracker, Blavatnik School of Government and Google community mobility reports.
Note: The OxCRGT stringency index records the strictness of “lockdown style” policies that primarily restrict people’s behaviour. Higher values indicate more restrictions. The Google index tracks visits to the workplace and shows the deviation in mobility on a given day from the median value, for the corresponding day of the week, during the five-week period 3 January to 6 February 2020. A higher, less negative number indicates mobility that is closer to usual. Both indices are daily and averaged over April, May and June.
Figure 5
Euro STOXX 50 volatility index provides a forward-looking measure of uncertainty
Source: Refinitiv Datastream and EIB staff calculations.
Figure 6
Investment growth in Q2 2020 and measures of uncertainty
Source: EIBIS 2020, Eurostat, OECD national accounts and EIB staff calculations.
Lockdowns and social distancing across the European Union have led to a large decline in corporate cash flows because firms are not able to reduce costs proportionally to the decrease in revenues (Chapter 3). Figure 7 shows the steep decline in the gross entrepreneurial income of non-financial corporations, which is the closest approximation in the European System of National Accounts to aggregated firm-level cash flow. The decline was more than twice the falloff seen in the past two recessions, one which was sparked by the global financial crisis and the other by Europe’s sovereign debt crisis. Lower cash flows mean lower liquidity which will eventually undermine the net worth of firms, affecting their ability to borrow and invest. Expectations that firm’s net worth will decline are already affecting investment decisions, but that negative sentiment will intensify in the coming year. A lack of investment could push down firms’ net worth even further, creating a negative loop.
Figure 7
Gross entrepreneurial income of non-financial firms (% change vs. a year ago)
Source: Eurostat.
Corporate investment
Investment cycle and outlook
The near-term outlook for firms deteriorated significantly with the onset of the coronavirus pandemic. Expectations of non-financial corporations about the overall economic climate, as well as the business prospects in their own sectors and the availability of finance, had already deteriorated in 2019, as documented in last year’s edition of the investment report (EIB, 2019). Still, the situation had worsened considerably by this summer with the EIBIS 2020 survey (Figure 8). A net balance of [6] 57% of firms in the European Union expect the economic climate to deteriorate in the next 12 months. About 25% (in net terms) expect business prospects to deteriorate in their sector or industry. The ability of firms to fund their own investments is expected to deteriorate. The percentage of firms that said they expected a net improvement in their ability internally finance their investments over the following 12 months was 18% in 2019. By 2020, however, 23% (in net terms) of firms said they expected the situation to deteriorate in the next 12 months. Expectations about the availability of external finance are broadly neutral following the massive interventions from the European Central Bank, national governments and the European Union (see Chapters 1 and 3).
Figure 8
Investment drivers in the European Union, firms expecting an improvement/deterioration (net balance)
Source: EIBIS 2016, EIBIS 2017, EIBIS 2018, EIBIS 2019 and EIBIS 2020.
Base: All firms (excluding don’t knows/refusals to respond).
Question: Do you think that each of the following will improve, stay the same, or get worse over the next 12 months?
Expected investment for the current year also plummeted, in line with the extraordinary deterioration in economic sentiment (Figure 9). Planned investment changed from an EU average of 13% (in net terms) of firms expecting an increase in 2019 compared to the prior year, to an EU average of 28% (in net terms) of firms expecting a decrease in investment in 2020 compared to the prior year. Country variations are significant (Figure 9a) – from a 60 percentage point deterioration in Latvia to a 9.6 percentage point contraction in Romania. As discussed above, some of this decline can be explained by the pandemic. While it is still too early to assess the direct impact of government lockdowns and other restrictions on investment, those restrictions are expected to