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Chief Economist's note: COVID-19 could herald a new era of European divergence

COVID-19 could herald a new era of European divergence

Yael Selfin, Chief Economist in the UK discusses the COVID-19 pandemic impact on European economies.

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Yael Selfin - Chief Economist at KPMG in the UK.

Chief Economist

KPMG in the UK

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Also on home.kpmg

Key points:

  • Uneven evolution of the pandemic across Europe could widen the gap in growth potential between, and within, countries 
  • Southern European countries, with economies that are heavily reliant on tourism, could be hit by two lost high seasons
  • A gap in fiscal capacity favours countries with fiscal room to spend in support of their economies, despite EU wide initiatives

A resurgence in COVID-19 infections has led to additional measures being announced across Europe in the past two weeks to contain the pandemic. The inevitable economic fallout could slow and even reverse, the nascent economic recovery, bringing with it the danger of a double-dip recession.

While most European economies are under significant strain from the pandemic, their prospects coming out of the crisis diverge. The uneven exposure to the pandemic, varying fiscal room for manoeuvre and the different sector make-up have the potential to drive a wedge between the growth rates of different European economies. 

Initial impact of COVID-19

The impact of the pandemic so far has partly reflected the severity of the national outbreaks. While by mid-October 2020, Spain, UK and Italy have seen more than 600 deaths per million of population, Germany saw only 114 and Greece 41.

Pre-existing issues in some economies exacerbate the impact of the pandemic: Spain, which entered the COVID-19 recession with an already high unemployment rate of just under 14%, saw it rising to 16.2% by August. High levels of unemployment will make it harder to sustain a strong recovery through growth in consumer spending. Other economies, like Greece and Ireland, are still dealing with legacy issues from the previous recession. For Greece, the recovery from the previous crisis is not over: banks are still dealing with non-performing loans on their books, and the country is now facing uncertain prospects for the tourism sector.

The sectoral make-up of European economies has an impact on their economic exposure. In particular, the pandemic has dealt a major blow to the travel and hospitality sectors. Greece is an example where, despite a limited number of cases, GDP could fall by nearly 8%. Spain could see a fall of over 12% in 2020.

chart-01-new

Source: Bruegel, chart shows the level of immediate discretionary fiscal measures adopted in response to COVID-19 by 3 September 2020.

Click here to view a lager version of the image.

The initial round of support has also varied. Germany is well in the lead in terms of direct support to the economy: the measures add up to 8.3% of GDP, compared to 3.4% in Italy; 3.7% in Spain; and 4.7% in France. These differences reflect a gap in fiscal capacity. The 750bn euro recovery fund agreed in July could help address some of that, as more fiscally constrained nations are set to receive a greater share of support.

Recovery and the coming second wave

There’s a risk that inherent economic conditions will create a multi-speed recovery between different European economies. While the latest surveys show that no single economy has fully recovered, a number of groups emerge.

chart-02-new

Source: European Commission. The economic sentiment indicator (ESI) is a composite indicator aimed at tracking GDP growth. It is a weighted average of the balances of replies to selected questions addressed to firms in five sectors covered by the EU Business and Consumer Surveys and to consumers. The sectors covered are industry (weight 40 %), services (30 %), consumers (20 %), retail (5 %) and construction (5 %). Balances are constructed as the difference between the percentages of respondents giving positive and negative replies.  

Click here to view a larger version of the image.

The latest European Commission’s economic sentiment indicator points at Poland, Bulgaria and Denmark faring the worst, with the composite economic sentiment mark around 20% below average levels for those countries. However, for 19 members of the EU, including Ireland, Italy and Spain, economic sentiment is almost 10% off its average levels. This group includes many Southern European economies hardest hit by the pandemic, and economies reliant on tourism and hospitality. Ireland, also in this group, faces the potential fallout from a damaging Brexit due to its strong trade links with the UK.

Another group, consisting of the remaining nine economies, could have faster growth prospects in the coming year. Strong exporting countries like Germany and Netherlands, could benefit from stronger external demand from Asia. It also includes France, which has recently announced a significant stimulus package of around 4% of GDP. Taken together, and especially in the case of the larger economies in this group, these have tended to see a smaller fall in output this year and could experience a faster recovery. 

These features, already apparent in survey evidence, could see countries falling into one of two diverging growth groups during the recovery phase. As these groups grow further out of sync with one another, this could lead to frictions for policy within the bloc.

 

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