Toward a More Resilient Europe

By Poul M. Thomsen
Jul 13 2020 (IPS)

Europe, like the rest of the world, faces an extended crisis. An
element of social distancing—mandatory or voluntary—will be
with us for as long as this pandemic persists. This, coupled with
continued supply chain disruptions and other problems, is
prolonging an already difficult situation. Based on
updated IMF projections
released last month, we now expect real
GDP in the EU to contract by 9.3 percent in 2020 and then grow by
5.7 percent in 2021, returning to its 2019 level only in 2022. If
an effective treatment or vaccine for COVID 19 is found, the
recovery could be faster—but the opposite would hold true if
there are large new waves of infection.

Some European countries will face a tougher recovery path than
others. Several went into the crisis with entrenched product and
labor market rigidities holding back their growth potential. Others
depend on industries that are tightly integrated into cross-border
supply chains, leaving them deeply vulnerable to disruptions of
such links. In several large euro area countries, slow growth has
coexisted with high public debt and limited fiscal space,
constraining the ability to cushion shocks. Inescapably, sharply
divergent initial conditions are likely to result in a highly
uneven recovery across Europe.

Europe’s high-debt countries will bear the brunt of the social
impact. For decades, several of these countries have seen their
public debt burdens ratchet up in times of trouble and
stabilize—but not fall—in good times. The stepwise pattern of
rising debt speaks to a weak record of addressing structural
deficiencies, whether due to institutional rigidity or insufficient
political will. Results have included high unemployment and
emigration, especially among the youth, and a trend toward
less-progressive taxation—but pensions have largely been
protected. COVID 19—a disease that calls for protection of the
elderly but leaves the young shouldering much of the
cost—complicates an already difficult demographic situation.

Fiscal policies for a transforming Europe

Against such backdrops, policies—especially national fiscal
policies—need to start being repositioned for a longer crisis. At
the outset of the pandemic, lockdowns were a vital tool to save
lives. To help economic capacity survive a short but extreme
disruption and allow activity to promptly bounce back afterwards,
fiscal policies were eased sharply. Months later, fiscal support
remains as vital as at the onset. But, as dislocations persist,
resources will become stretched. Now is the time, therefore, to
think ahead and reassess how best to use limited fiscal space
without unduly burdening future taxpayers. The longer the slump,
the greater will be the need to carefully target support for firms
and households in the high-debt countries.

Policymakers must also recognize that the post-crisis economy
may look very different from the economy of 2019. It is becoming
clear that we are in the throes of—and that we need—permanent
change. COVID 19 has reminded us that nature still reigns supreme,
that environmental degradation must stop, and that investing in
resilience is good policy. Moreover, prudence requires us to
consider that this pandemic could last several years, and may well
be followed by future pandemics. Europe must strive for a new,
greener economy, one that can operate efficiently even with
prolonged social distancing. It may take many years to complete,
but transformation needs to be nurtured starting now. We cannot
just return to the way things were before.

Change is already underway, with winners and losers.
has emerged as a key bulwark of resilience, yet
also as a divide. Across Europe and beyond, countless employees are
adapting to remote work, students to remote learning, doctors and
patients to telemedicine, and firms to internet-based sales and
door-to-door delivery. Countless others, however, are shut out.
Many contact-intensive activities—hospitality, travel, and
more—could take years to recover. Some outputs—take coal-fired
power or carbon-emitting vehicles—may slip into terminal decline.
Again, some countries will be hit harder than others, and
inequalities could grow both across and within national borders. We
may not yet be able to fully envision the new normal, but the
transition has begun.

Public funds must be used to steer the needed resource
reallocation while protecting the most vulnerable. In labor and
product markets, the focus should be on flexibility, including by
ensuring that short-time work schemes that tie workers to their
employers are kept temporary. In the corporate sector, support
programs must embed incentives that encourage uptake by firms with
strong business plans and discourage uptake by firms on a path to
failure. As liquidity needs become solvency needs, state aid may
need to include equity injections—various European initiatives
are already moving this way. Clarity on carbon pricing will also be
important to set the stage for a climate-friendly recovery of
private investment. Finally, public investment can and should take
the lead, focusing on greening, digitalization, and other aspects
of resilience.

Given divergent national conditions, there is a strong case for
joint EU fiscal action. Supporting the recovery will continue to
require substantial fiscal resources. By focusing EU funds on
countries hardest hit by the pandemic or with less fiscal space,
lower income levels, and greater environmental damage, the “Next
Generation EU” package stands to improve outcomes for the single
market as a whole. To do so, however, it is vital that it serve as
a catalyst and not a substitute for structural reforms and prudent
fiscal policies. With fundamental limits to the size of any joint
EU assistance, the responsibility for ensuring that debt burdens
are sustainable will remain squarely at the national level. Even
with low borrowing costs, all countries will need to partner
upfront stimulus provision with credible medium-term policy

Preserving financial stability and the supply of

Through the acute crisis phase and beyond, monetary policy will
need to remain strongly accommodative. With crisis-related demand
shortfalls further weakening the inflation outlook, central banks
must continue to deliver substantial stimulus and ensure that
financial markets remain liquid. In practice, this means policy
rates must remain at extraordinarily low levels for now, supported
by net asset purchases that implicitly look to bond spreads and
issuance volumes. Once the period of stress has passed, however,
there will be a need for introspection—reflecting on the many
years of missed inflation objectives, on how to properly demarcate
monetary policy from fiscal policy, on the global decline in
equilibrium real interest rates as savings outpace investment, on
the choice of monetary instruments, and more. The European Central
Bank’s strategic review remains as essential as ever.

Finally, another key priority in the coming period will be to
ensure an uninterrupted supply of bank credit to the economy.
History has taught us that, when efficient savings allocation
breaks down, crises tend to last longer. For now, most European
banks have the capital and liquidity they need to expand credit.
But, as this crisis wears on, there will be many defaults, and
these could erode bank buffers and lending capacity. Potentially,
therefore, one feedback loop of this crisis may simply be time: the
longer the pandemic, the greater the credit disruption, and the
slower the post-pandemic recovery. It is vital that supervisors
prepare banks for the coming test. Robust lending standards must be
upheld, losses provisioned for fully and transparently, and
restructurings of bad assets pursued actively to preserve value. In
some cases, bank recapitalization may prove necessary.

A calibrated policy mix

With many difficult challenges lying in wait, managing this vast
crisis will call for an increasingly calibrated approach going
forward. The initial emphasis on opening the fiscal and monetary
floodgates had its place. As time passes, however, policymakers
must reflect also on longer-term considerations. Even as low
borrowing costs soften some of the tradeoffs, responsible
policymaking will still need to weigh immediate imperatives against
future burdens on young taxpayers and new generations. Difficult
reforms must be pursued with renewed determination.

The overarching policy goals are not one, but two: to save lives
now, and to ensure that Europe emerges with a greener and safer
economy for the long run, one where future generations can thrive

This article is from International Monetary

The post Toward a
More Resilient Europe
appeared first on Inter Press Service.

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Toward a More Resilient Europe