THE FRUGAL FOUR AND COVID-19 IMPACT

Source: OECD Economic Outlook June 2020

1. Austria

GDP is projected to contract by 6.2% in 2020 if there are no further virus outbreaks (the single-hit scenario), and by over 7% if there is a renewed outbreak later this year (the double-hit scenario). The economic recovery will take time, with output still below its pre-crisis level by the end of 2021. Unemployment, and the number of people on short-time work schemes, has soared and is projected to remain high through the projection period. Given additional spending as part of the policy response and weaker tax revenues, a large government budget deficit will open up. The comparatively low rate of inflation is expected to slow in the near term, picking up somewhat in 2021.

The swift policy response has ensured ample support for firms and households through liquidity injections, tax deferrals, credit guarantees and the short-time working scheme. Policymakers should ensure that the support programmes evolve according to the health and economic situation and continue to complement and replace existing broad measures, with more focused support to limit adverse side-effects on the efficient allocation of resources.

The policy response entailed a significant fiscal stimulus. The authorities announced several measures to support businesses, households and the health sector in mid-March, which were accompanied by an easing of euro area monetary policy. The total COVID-19 budget envelope is EUR 38 billion (around 9% of GDP), including credit guarantees and tax deferrals, and is gradually being implemented and operationalised. Credit guarantees (up to EUR 9 billion) are provided for up to 100% of loan amounts to help businesses to prevent liquidity shortfalls. A tranche of initially EUR 4 billion was dedicated to fund disbursements on medical supplies, to support the care-taking system, hardship cases across particularly vulnerable businesses and financing of the short-term work scheme. Employers can reduce working hours to as low as 10%, while employees receive 80-90% of their regular pay. Due to a high number of applications, the funds for the short-time work scheme have already been increased to EUR 12 billion. In addition to these measures, the authorities announced a recovery package for the hospitality sector of EUR 500 million in mid-May.

GDP could contract by more than 7% in 2020

The lockdown led to a decline of around 30% of economic activity until it started to be eased. In case of a second outbreak of the virus, GDP would decline by over 7% in 2020, whereas in the single-hit scenario, which assumes no further outbreaks and that restrictions continue to be eased in the second half of the year, GDP will decline by 6.2% in 2020. Trade and investment will remain particularly weak given continued uncertainty in both scenarios. Employment will recover and this will allow many workers on the short-time working scheme to get back to work. Nevertheless, at the end of 2021, unemployment will remain at 5.7% in the double-hit scenario and at 5.2% in the single-hit scenario. Inflation will weaken in the short run. Risks remain high. In particular, the tourism sector is a key employer and exporter, but it consists mainly of SMEs, often family-owned and usually highly leveraged, implying rather small liquidity buffers. If confinement measures and travel restrictions continue to prevent tourists from travelling to Austria over the summer, a wave of insolvencies in that sector may follow, with adverse consequences on aggregate output, employment and exports.

Policymakers need to support the recovery

Policymakers need to support workers and firms while activity remains disrupted during the recovery phase. However, they also need to ensure that well-intended policy measures do not entail adverse longer-run side effects, and be prepared to unwind public support in a timely manner. This concerns particularly the withdrawal of government guarantees for corporate loans. Policymakers should prevent otherwise viable firms from exiting the market if this is due solely to a temporary shortfall in liquidity. However, a prolonged government guarantee may increase fiscal costs and risk negative effects on the efficient allocation of resources and productivity from enterprises that only remain in business due to public support. Policymakers should instead focus on a fast resolution of insolvent firms, either through debt forgiveness or from conversion of corporate debt into equity. Policymakers should consider the possibility of re-adjusting the economy in a more sustainable and inclusive manner, for example by beginning to implement measures to counter climate change or using more digital services in education and government.

2. Denmark

Containment measures to curb the pandemic and associated uncertainty will cause a sharp contraction in economic activity, by more than 7% in 2020 if there is another virus outbreak later in the year (the double-hit scenario) and by almost 6% if further shutdown measures are avoided (the single-hit scenario). A second outbreak would result in significant scars from prolonged unemployment and many bankrupt businesses, delaying the recovery. In the single-hit scenario, the brief and more limited shutdown than in other OECD countries combined with sizeable government support will limit economic and well-being costs. In both scenarios, favourable export specialisation partly weathers the initial trade disruptions, but eventually external demand will largely determine the recovery path. Forceful fiscal action has protected the economy and limited the rise in unemployment. Temporary and broad support schemes for businesses and workers have been implemented and prolonged once. They should be allowed to expire and be replaced by more targeted support to viable businesses and sectors as the reopening phase matures and in case of a second outbreak. This will be important to avoid a surge in zombie firms and to preserve a flexible labour market that facilitates a needed reallocation of workers to new jobs. Further public investments to reduce emissions and mitigate climate risks would be timely to accelerate and green the recovery.

Economic activity dropped by up to one-fifth

While in place, the containment measures may have reduced economic activity by 10-20%, according to national estimates. Hotels and restaurants, cultural activities and some services almost shut down completely, whereas around one-fifth of activity stopped in the manufacturing, trade and transportation sectors. Payment transactions likewise indicate a 10-20% reduction in consumer spending and electricity consumption fell by around 10% on workdays. The drops in consumer and business confidence are of the same magnitude as during the global financial crisis, but are much more abrupt. Unemployment increased fast during the second half of March, but the increase then slowed markedly. A job retention scheme agreed between the government and social partners allowed employers to retain more than 7% of the labour force on furlough with up to 90% wage subsidies.

The fiscal support to firms and workers is massive

Policymakers acted decisively and implemented discretionary fiscal support of around 5% of GDP for 2020. Additional support to businesses through liquidity measures, notably tax and VAT deferrals, and government guarantees brings total support close to 18% of GDP. The vast amount of cash support is devoted to the job retention scheme and compensation schemes to cover companies’ fixed costs and incomes of self-employed with sizeable drops in revenue. Other initiatives include compensation to hard affected cultural activities, extending unemployment benefit periods and providing loans to entrepreneurs. A social policy package aims to help vulnerable groups with additional protection and preventing isolation. The financial sector has committed to assist firms and households with additional loans and payment holidays, backed by a release of the counter-cyclical capital buffer and extraordinary lending facilities from the central bank. The sole objective of monetary policy remains to keep a hard peg to the euro, which required an odd policy rate increase to -0.6% by mid-March.

The recovery will be gradual and depend on the external environment

Both scenarios assume continued lifting of containment measures with almost all economic activity resumed by August. Pent-up demand from household consumption and business investment will initially boost the recovery. While a large share of furloughed workers is expected to return to their job, a delayed unemployment surge is foreseen, also from expiring notice periods. Layoffs by late 2020 are assumed to be substantially higher in the double-hit scenario as a second shutdown in some sectors would push more firms into bankruptcy and increased uncertainty would delay investments. This would leave permanent effects on the economy from labour market exits, eroding skills and loss of firm-specific knowledge. The main risks to both scenarios relate to the external environment. Exports have a large share of pharmaceuticals and food products, providing more resilience to trade disruptions. Still, collapsing demand in export markets could result in a larger-than-expected contraction and an even slower recovery.

Policies should retain a flexible labour market and competitive businesses

The restart of the economy should take advantage of the strong labour market institutions in place, including opportunities for re-skilling. The job retention scheme has provided a welcome temporary freeze of employer-employee relations, but contrasts strongly with the Danish tradition of flexibility and high job turnover. Further extensions beyond those already implemented should be carefully considered and more emphasis put on short-time work and upskilling. The government has taken welcome steps to front-load public investment in municipalities and boost energy renovation of social housing. Structural initiatives to accelerate the government’s ambitious climate agenda should also be considered as part of a green recovery. Short-term stimulus may be achieved through staggered implementation, such as lowering some distortionary taxes and fees, while announcing a future increase in the carbon tax.

3. Netherlands

The economy has been hard hit by the COVID-19 virus. Output is set to shrink by 8% in 2020 before picking up in 2021 if the current outbreak is overcome and restrictions are gradually lifted from mid-May (the single-hit scenario). If there is a second wave of the virus later in 2020, GDP is expected to decrease by 10% and the rebound will be considerably slower (the double-hit scenario). The fall is driven by domestic demand in both scenarios, including private consumption and investments. Pent-up consumption demand will drive the initial pick-up, with investment lagging due to spare capacity and lingering uncertainty, but output will remain below pre-crisis levels by the end of 2021 in both scenarios. Unemployment will remain well above 2019 levels throughout 2021. Automatic stabilisers and discretionary spending are supporting businesses and households, pushing the fiscal balance into deficit. The government has implemented timely policy measures, including cash support for up to 90% of the wage bill, tax deferrals and credit guarantees for companies and has eased access to social assistance for the self-employed. Going forward, policies need to gradually shift focus to boosting demand while addressing structural challenges within housing and pension policies, broadening social security coverage and reducing nitrogen and greenhouse gas emissions.

The lockdown triggered a sharp economic contraction

 The Netherlands has been relatively hard hit by the virus, as its industry structure, with a strong reliance on trade and professional services, makes the economy vulnerable to distancing measures. Furthermore, openness to international trade and leveraged households create particular vulnerabilities. Sectors accounting for 36% of the economy were directly affected by the lockdown, although many activities, for example construction and retail trade, could continue subject to distancing measures. Consumer confidence fell sharply in April and May, unemployment insurance claims soared, and economic sentiment plummeted to record lows in both manufacturing and services

Policy has been timely and supportive

The government implemented discretionary support measures amounting to 2.5% of GDP and let the automatic fiscal stabilisers operate fully. Support measures include paying up to 90% of the wage bill of affected companies at an estimated total cost of 1% of GDP, direct cash support to companies and eased access to social assistance for the self-employed. Additional off-balance-sheet support has been provided by means of deferring taxes and social security contributions and extending credit guarantees. Financial institutions’ capital requirements have been eased, market regulations adapted, and new mechanisms implemented to support corporate restructuring and mediate bankruptcy disputes.

Output and employment will only recover gradually

Output is forecast to shrink by 10% in 2020 in the double-hit scenario, where a second wave of infection leads to renewed restrictions in the fourth quarter. In the single-hit scenario, where lockdowns are phased out gradually from mid-May, annual growth is set to shrink by 8%. Ongoing restrictions, low confidence and the weak global environment contribute to keeping GDP below its pre-crisis level at the end of 2021 in both scenarios. The labour market suffers, with labour market participation falling and unemployment rising considerably. Employment will recover only partially in either scenario, and weak demand will push inflation below zero for an extended period of time. The fiscal balance will move from surplus into deficit even as the economy picks up. Public debt (Maastricht definition) will increase from 48% of GDP to 65% and 72% in the respective scenarios.

Households’ inflated balance sheets, with large, illiquid pension and housing assets combined with high housing-related debt can lead to even weaker consumption than expected, notably if the crisis results in lower house prices. Furthermore, the liquidity ratio of pension funds has fallen below regulatory requirements. If this situation persists, it could force funds to increase contributions or reduce pensions, dealing a further blow to private consumption. Increased default rates on mortgages are unlikely, but liquidity problems in the business sector turning into solvency issues could risk unsettling financial market. Furthermore, the economy is particularly sensitive to developments in global trade.

Policies should boost resilience and support demand

Current policy adequately protects businesses and people against the short-term consequences of the COVID-19 outbreak and the lockdown. Fiscal policy should remain supportive going forward, but needs to shift to general demand support after the end of the lockdown. Such stimulus should support necessary structural change, inclusiveness and the environment, including broadening the coverage of social security benefits, expanding renewable energy generation capacity and reducing nitrogen emissions from agriculture. Low interest rates create an opportunity to reduce further tax subsidies to home-owners by phasing out mortgage rate deductibility. The crisis accentuates the need to reform the pension system to make it fairer for the young and more resilient to low interest rates and asset price fluctuations.

4. Sweden

The COVID-19 pandemic has triggered a severe recession. GDP is expected to fall by 7.8% in 2020 assuming another virus outbreak later in the year and by 6.7% if the virus outbreak subsides by summer. While containment measures have been less stringent than in most other OECD countries, private consumption has fallen markedly and is set to recover only slowly. Both disruptions to supply chains and tumbling demand have led to stoppages in industry. Export weakness is expected to linger, and the investment slump even more so, as high uncertainty compounds the effect of weak demand.

The government has implemented a wide range of measures to support local authorities and households and to protect jobs and companies. The short-term work scheme is containing the rise in unemployment, which is nevertheless rapid. Tax deferrals, reduced social security contributions and credit guarantees give breathing space to companies. The monetary and financial authorities provide ample liquidity and support for lending, along with eased macro-prudential rules. Further investments in green projects and human capital will be required to shore up employment and ensure a sustainable recovery. Healthy public finances provide fiscal space to further buttress the economy, if needed.

Economic activity is collapsing

The pandemic affects most economic activities, albeit with large differences. Worst hit are transport, tourism, accommodation, restaurants and cultural activities, where businesses are shut down or running at a fraction of pre-crisis activity. Bankruptcies are soaring, especially for hotels and restaurants. Sales of necessities, notably food, have remained solid, but those of other goods have collapsed, including online sales. Export orders tumbled in April. Weak global demand, together with value chain disruptions and health safety issues, have entailed plant closures, especially in the automotive industry. The number of short-term layoffs and job termination notices has risen sharply.

Government support to the economy is massive

The government has introduced a wide range of measures to shore up the economy. Discretionary fiscal easing amounts to 4.8% of GDP. Adding liquidity measures, notably tax deferrals and state guarantees, total policy support could reach 16% of GDP. These policies are limiting the damage inflicted by the crisis on jobs and companies, protecting the most vulnerable and preserving economic and human capital to speed up the recovery once the crisis is over. The more generous short-term work scheme put in place is most important for the well-being of workers and for preserving skills for the recovery. For those who nevertheless lose their jobs, the unemployment insurance has temporarily been reinforced and education opportunities have been expanded. In addition, temporary reductions in employer social contributions, the temporary shouldering of the cost for sick pay by the government and a reorientation of support to cover part of the fixed costs of companies experiencing large losses in turnover give breathing space to businesses and targeted measures support some of the worse hit sectors. The government also increased grants to municipalities and regions, including for green jobs, which is essential to cover increased welfare costs and compensate for lower tax income. The Riksbank announced a programme of corporate lending via banks (up to about 10% of GDP), new asset purchases (up to around 6% of GDP) and other steps to increase liquidity. The financial supervisory authority lowered the counter-cyclical capital buffer to zero and suspended the mortgage amortisation requirement.

The recovery will be slow and a pandemic resurgence would delay it further

Economic activity is expected to pick up starting by the start of the summer, but slowly, as households exercise caution and purchasing power suffers from lower income, due to the fall in activity and high unemployment, and lower wealth, due to lower equity and housing prices. While government support partly shields households from the crisis, it will be slow to translate into higher spending, even though targeting lower-income households will help. Reorganising industrial production also takes time and the weakness of global demand and high uncertainty will hold back investment. Lacking demand is bound to exceed the reduction in supply capacity, pulling inflation down. Reflecting the sluggish recovery, unemployment will ebb very slowly. The double-hit scenario entails both another short-term blow to the economy and more severe long-term consequences, as bankruptcies increase further, longer unemployment spells erode human capital and heightened uncertainty delays investments even more

Additional policy action may be needed to support the economy

The government has taken appropriate temporary measures to buttress the economy and alleviate hardship. Depending on the speed of the recovery, such measures may need to be prolonged. Part of the tax deferrals may need to be converted into tax cuts. Even though some steps to reinforce active labour market policies have already been taken, additional training and support for job search may be necessary. Further fiscal and monetary stimulus may be required to boost demand in the recovery phase. Low government debt provides fiscal space, despite the already huge increase in public spending. Further support could be targeted at sectors durably affected by the crisis or transitioning towards greener production.