The EIU forecasts a 7% average contraction in the economies of western Europe in 2020. The depth of the recession will vary among countries depending on their coronavirus caseloads, and the length and severity of their lockdowns.
What happens in 2021, however, will arguably be more important, and will be determined by a broader range of factors, including starting points, the fiscal response, economic structure and export dependencies.
We expect the economic bounce-back in Europe to lag the global average, and do not expect real GDP to recover to its 2019 level until 2023. Germany will be the first major European economy to recover, and Italy the last.
The key question will be how long it takes for confidence to return. With holiday-makers still acting with caution next year, we expect tourism-dependent economies to struggle the most.
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The EIU’s forecasts for western Europe show that even with a bounce-back starting in the second half of this year, the region’s economy will still be about 2.5% smaller in 2021 than it was in 2019. This suggests a slower recovery than in eastern Europe, which mostly had a much lower coronavirus caseload, but also than in the US, where cases have been much higher. This reflects greater export dependency in Europe than in the US, which is a vulnerability when import demand in the rest of the world is depressed and supply chains are disrupted; but also a slower structural adjustment in the wake of the crisis. In part, this is because of the reliance on furlough schemes in addition to unemployment benefits, which will mean a less agile reallocation of resources.
In assessing the strength of the economic recovery across Europe next year it makes sense to look at levels rather than growth rates. The Italian and Spanish economies will record robust economic growth rates in 2021, but given the scale of their recessions in 2020 will remain almost 4% and 6% below their 2019 levels, respectively. We expect Luxembourg and Denmark to be the first countries in the region to see real GDP return to its pre-crisis level, after comparatively modest contractions this year. In contrast, tourism-dependent Iceland will not reach this milestone until 2024, and Italy not until after our forecast period, in 2025. There are several reasons for these disparities.
Fiscal capacity is among the most important. One reason why we expect the German economy to recover comparatively quickly is that the government is conducting the biggest fiscal stimulus programme in the EU. This includes over €1.2trn in budgetary measures and liquidity support to soften the downturn, and a stimulus package to kick-start the recovery. Germany also accounts for 47% of all state aid packages in the EU, including a €9bn bail-out of Lufthansa, the country’s largest airline. This generosity is possible because of the healthy state of the government finances going into the crisis—a budget surplus and public debt below 60% of GDP—which is not the case across the region. The Italian government adopted an unprecedented fiscal package to support the economy, but direct fiscal stimulus (excluding tax deferrals and liquidity and guarantee measures) accounts for just below 3% of Italy’s 2019 GDP, compared with 13% of GDP in Germany.
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Fiscal support is only effective if it is channelled efficiently to the right recipients, and there are reasons to doubt that this will be the case in Italy. Complex bureaucracy means that Italy has been slow to deliver fiscal support to employees and families through the furlough scheme: by late May, only 60% of beneficiaries had received the disbursements to which they were entitled. Support for businesses, meanwhile, is mostly channelled through the banking sector, and although balance sheets have been strengthened in recent years, many local credit institutions are still fragile. The weak fiscal position of the government (with public debt at 135% of GDP in 2019) may also undermine the credibility of public loan guarantees, making banks reluctant to extend credit. Finally, a large share of the €55bn fiscal package adopted in May consists of a plethora of micro-interventions, with subsidies for air travel, cinemas, holiday resorts and many others that risk being ineffective and wasteful.
The structure of the economy is also relevant to the pace of the recovery in 2021. Germany is at an advantage because of its large industrial sector—at about 30% of GDP, versus just under 20% in France and the UK. Pent-up industrial demand and order backlogs can start to be fulfilled as soon as restrictions are eased, and activity can be ramped up quickly, benefiting not only Germany but also its suppliers in central Europe. The recovery in key export markets will be especially important for smaller economies: those reliant on Italian demand will take longer to recover than those reliant on Germany. In contrast to manufacturing, the services sector will struggle to recover lost consumer demand, and activity will return only slowly given weak consumer confidence. France and the UK, both with services sectors equivalent to almost 80% of GDP, will follow similar trajectories, with real GDP returning to its 2019 level only in 2023.
Dependence on tourism is a structural disadvantage during the pandemic. We expect travel and tourism to remain subdued next year as holiday-makers continue to worry about the risk of contagion, especially where air travel is concerned—even as official restrictions (including the border closures and quarantines in place this year) are eased. This means that those economies worst hit by the fall in tourist arrivals in 2020 will experience a sluggish recovery in 2021. The countries most reliant on tourism are Iceland (total contribution to GDP of 22.8% in 2019), Greece (20.8%), Portugal (16.5%) and Spain (14.3%). These are the economies we expect to have recovered the least by end-2021—with Spain experiencing the deepest contraction in Europe this year.
The UK will benefit in 2021 from its flexible labour market and the ability to borrow cheaply and in its own currency, enabling it to leverage public spending to support its recovery. However, the risk of no-deal disruption at the end of this year is high, as negotiations with the EU on the country’s future relationship have yet to make significant progress. Even if a deal is reached, it is likely to involve increased trade frictions and tariffs from January 2021, sharply reducing the competitiveness of British exporters just as the recovery begins. A robust deal that allows for phased implementation of tariffs would mean a softer impact, while a disorderly Brexit leaving businesses little time to prepare would lead to a slower recovery and more business failures. For the moment, a high degree of uncertainty will constrain business confidence.
We monitor the world to help you prepare for what’s ahead. Find out more about The EIU’s Country Analysis service.
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