Executive summary
European policies reacted forcefully to the crisis, but risks remain high.
The COVID-19 pandemic plunged the EU into its worst-ever recession (Figure 1), adding economic hardship to a high death toll. Strict containment measures closed large swathes of economic activity and depressed confidence in the face of elevated uncertainty. Except for Ireland, GDP fell in 2020 in all EU countries, varying from -1 to -11%. The largest drops affected countries forced into the strictest lockdowns or whose economic structure was also most sensitive to them.
Source: OECD (2021), OECD Economic Outlook: Statistics and Projections (database).
Forceful policy reaction helped mitigate the negative impact of the crisis. The ECB expanded significantly its support to the euro area economy, which also benefitted other EU countries through trade linkages and by avoiding financial instability. Unlike in the global financial crisis, national fiscal support was massive, allowed by the activation of the general escape clause of the Stability and Growth Pact. In addition, the EU beefed up existing tools (like the ESM) and adopted two new temporary common fiscal instruments funded by joint EU borrowing: one to support employment through loans to member states (SURE) and one to finance national recovery plans through grants and loans (Next Generation EU). In both cases, support has been mainly allocated to the most affected countries, displaying solidarity and enlarging fiscal space. Swift and effective implementation of recovery plans is the key challenge to turn this opportunity into success.
Vaccination took time to gather speed, but is now giving hope of a more robust recovery. As confinement measures are gradually lifted, growth is projected to rebound strongly in the course of this year, partly due to pent-up demand, and to remain robust in 2022 (Table 1). Still high household savings weigh on growth prospects. Low vaccine effectiveness in case of virus variants or insufficient coverage of the population are downside risks.
A muted recovery would increase inequalities, fueling discontent and hurting trust in the EU.
The crisis could leave scars and reopen old wounds. The disproportionate impact of the crisis on service sectors with abundant low-skilled jobs may increase inequality and poverty. Soaring non-performing loans could threaten financial stability and slow down the exit of inefficient firms, hampering resource reallocation and growth.
The pandemic’s asymmetric territorial impact could compound regional divergence across the EU, such as widening gaps between large cities and rural areas. Some regions have been more affected by the pandemic than others. For example, Southern EU economies, partly due to their higher reliance on tourism and on very small firms, have recorded the largest GDP falls in 2020.
Next Generation EU and the 2021-27 EU budget have the potential to turn digitalisation, the green transition and globalisation into opportunities to increase potential growth and address regional inequalities. If unaddressed by policy action, digitalisation could worsen regional divergence, with further spatial concentration of growth and job creation. Likewise, pursuing carbon neutrality would disproportionately hurt regions heavily dependent on coal extraction and carbon-intensive industries. However, place-based policies, enhanced competition policy and EU support can help regions upgrade their productive specialisation.
The EU can better coordinate green investment and innovation and adjust its competition policy to new challenges.
Increasing investment is key to accelerate the recovery. Long subdued, higher public infrastructure investment can crowd-in private investment. Electricity grids, including cross-border interconnections, are a case in point. Moving to low carbon emissions in transport also calls for coordinated investment, such as an EU-wide interoperable recharging network for electric cars.
High-quality and affordable broadband connectivity is essential for innovation. It also increases resilience to public health emergencies and helps spread the productivity spillovers from large cities, namely by enabling teleworking. Remaining connectivity gaps in rural and remote areas thus need to be closed, in line with the objectives of the EU’s Digital Strategy. As in energy, licensing procedures should be simplified to ease network deployment.
The EU should reverse its decline in innovation (Figure 2) and enhance synergies between national efforts. To exploit the innovation potential of the green and digital transitions, it is key to pursue initiatives to combine public and private funding in cross-country collaborative R&D and industrial innovation projects. Spillovers should be enhanced by promoting participation by firms from less prosperous countries and regions.
Innovation is also a priority to enable convergence of poorer regions, where R&D investment tends to be very low. Stronger investment, which cohesion policy should support, will foster innovation diffusion among local firms. Productivity in lagging regions would also benefit from enhanced agglomeration economies. These can be fostered by public investment to reduce travel time to large cities and closer integration of regional cities with their surrounding territories.
Adjusting competition policy in view of technological and evolving globalisation challenges has been long due. Updating the competition tools may be needed, in tandem with regulation of large digital platforms, to tackle positions of entrenched dominance in digitalised markets, due notably to strong network effects, consumer lock-in or lack of access to data. In addition, there is a need to better avoid that dominant incumbents buy nascent firms to pre-empt future competition or thwart the development of new products, and to tackle distortive subsidies granted by non-EU governments.
The use of EU funding should be made more efficient to support regional convergence.
Efficient strategies for regional development require integrated use of EU funding and careful project selection. Instead of the first-come first-served approach sometimes adopted, selection procedures should compare applications on the basis of their contribution to regional development objectives. There is also a need for better coordination of rural development policy and cohesion policy in regions eligible for sizeable support from both.
Public procurement, which is central to cohesion policy and Next Generation EU spending, is often not competitive enough. Single bidding is common, and contracts tend to be awarded to suppliers of the same country, and even region, of the buyer. This can favour inefficient local suppliers, which harms regional development. Greater centralisation of procurement, professionalisation of procurement officials and transparency of procedures would help address these problems. Enhanced data collection requirements on public procurement by cohesion policy are thus welcome.
The deployment of EU funds, not least from Next Generation EU and cohesion policy, must not be marred by corruption and fraud. More effective investigations by EU bodies require stronger cooperation from member states, through timely transposition of relevant directives, operational assistance and judicial follow-up. Greater use of common risk-scoring tools would enhance fraud prevention and detection.
Next Generation EU can help reinforce European leadership in greening the economy.
Reducing EU net emissions of greenhouse gases to zero by 2050 requires significant acceleration in emission abatement (Figure 3). Reaching net zero implies electrifying most energy end use, generating most electricity from renewables, developing low-carbon fuels for sectors hard to electrify as well as carbon capture and storage, and increasing energy efficiency.
Higher carbon pricing, stronger regulatory standards and more innovation are key to achieve climate neutrality. Bringing transport and buildings into an Emissions Trading System (ETS), as recently proposed by the European Commission, could spur emission abatement, favouring take-up of electric cars and incentives for renovation. In both sectors, more demanding standards for energy efficiency are also essential. Accompanying targeted support to poorer households would be required. Innovation in batteries and clean hydrogen will speed up the reduction in emissions.
Steering finance towards low-carbon investments requires better assessment and disclosure of climate-related risks. These follow from both extreme weather events and mitigation policies, which require early writing off of high-carbon assets. Though improving, disclosures by banks and large companies are still at an early stage, which calls for more demanding standards.
Note: Excluding land-use, land-use change and forestry (LULUCF).
Source: Eurostat (2020), "Greenhouse gas emissions by source sector", Eurostat Database; European Environment Agency.
Extraction and processing of raw materials continues to increase (Figure 4), causing carbon emissions, pollution and biodiversity loss. To reduce materials use, circular economy policies encourage reuse, recycling and shared use.
Digital tools can support the circular economy by reducing information costs and fostering innovative business models, such as digital-based ride sharing. A digital passport could provide information on a product’s properties, like repair and recycling possibilities. Information on product durability can substantially influence consumer behaviour.