Three pandemic's scars on the euro area economy
The roll-out of vaccines enables us to take a peek at our post-pandemic lives. Economies across Europe are gradually reopening, businesses are rebooting, and people are getting back to their normal routines. But it's not going to be all that simple. Like all big shocks, the pandemic has left its scars in Europe and elsewhere around the globe that will still take some time healing.
Looking at the latest economic projections of the European Central Bank (ECB), it is evident that a return to the pre-pandemic growth trends is not expected over the next three years. This means that a quick and full restart is impossible for some part of the processes.
In this article, I will outline, as I believe, three currently most important headwinds to a smooth recovery or areas to be addressed by the governments, where policies to support sectors and population are required.
Chart 1. Pre-pandemic and June 2021 GDP growth projections, index 2019=100
Source: ECB's staff macroeconomic projections
Global supply chain disruptions
At the beginning of the pandemic, production lines stopped, and the volumes of international freight transportation contracted significantly as a result of various containment measures, border closures and rapidly falling demand. That, quite naturally, affected the work of producers and transporters. Production suddenly froze in various parts of the world and the ships transporting goods and materials from Asia to Europe and the US lay idle at ports.
In the middle of 2020, the population of the US and Europe under lockdowns increasingly started purchasing goods on the internet; the demand was progressively recovering, and production plants and the shipping industry gradually returned to business. Moreover, now, when the progress with vaccinations in Europe and the US has already enabled a gradual reopening of the economies and the production volumes are steadily climbing back to the pre-pandemic levels, the rise in demand has more than offset the dive observed in the middle of last year. The demand for transport services has also grown. As a result, the container shipping prices have also increased several times (Chart 2).
Chart 2. Container freight rates (Freightos Baltic Index; daily data; USD)
Current production capacity can no longer satisfy the swiftly rising demand. Because of the existing production chains (i.e. a company is only engaged in one stage of the production process, producing just some parts of the final product, which are then mostly shipped to producers at the other end of the world assembling the consumer products), businesses are facing new problems with shortages of raw materials. Producers are unable to supply the requested quantities of components and raw materials, and the shortages are passed on further along the supply chains. According to the survey conducted by the European Commission (EC), 23% of euro area manufacturing industry reported shortages of materials and equipment as factors limiting production in the second quarter of this year. In Germany, the overall percentage was even higher at 42%, the biggest material shortages being reported by manufacturers of computers and electronic products. 70% of those manufacturers as well as 58% of the automotive industry pointed to shortage of materials as a factor limiting production .
At the moment, this is a significant headwind to the global economic recovery, also creating a temporary, but notable upward pressure on prices. Stabilisation of the production will take some time; moreover, the delays in supplies can be expected to facilitate transformation of various global trade supply chains. European countries and the US are already considering the ways of restructuring their production, so that to decrease the dependency on Asia in terms of materials and prevent the occurrence of such disruptions also in any future crisis.
The pandemic has aggravated inequality everywhere, including in the euro area. Although the massive government support provided in Europe ensured that a large part of enterprises could afford not to lay off staff, it is evident that jobs were mostly lost specifically by the less protected workers having the lowest levels of education and income. Up to the fourth quarter of 2020, 7% of workers with a low level of education had been laid off. At the same time, employment of those with a higher education had even increased by 3% (Chart 3). The situation in Latvia is similar: the employment of workers with a higher education had grown by 3% and that of low income earners had declined by 8% year-on-year in the fourth quarter of 2020.
On the one hand, this tendency was attributable to the fact that the sectors related to tourism services – restaurants, hotels and personal care services – were the most hard hit by the pandemic. On the other hand, the ability to quickly regroup and start working from home was even more important. According to a US survey data , 70% of workers with a higher education, 30% of those with a high school education and only 17% of those with a basic education were able to telework. Assuming that the situation in the euro area could be similar, this resulted in a much higher rate of lay-offs among lower-education (and often also low-income) population.
Chart 3. Euro area employment by level of education, index 2019Q4=100
The pandemic has deepened the inequality also among school students. For example, the US data  show that, in periods when the containment measures included the closure of schools, students from better-off families participated in online math coursework much more actively that those from lower income families. As we know, during the peaks of the pandemic, many schools were closed all across the euro area, including Latvia.
At the start of the announced emergency situation, the learning participation of students from high income families declined by 40% and returned to the pre-pandemic levels already within a month. At the same time, for middle income and low income groups the respective decrease was 50% and 60%, and the participation never returned to the pre-pandemic levels. This was partly determined by availability of computers; nevertheless, the possibility for parents to work from home and support their children in the learning process is also likely to have had a significant effect.
Inequality levels were alarmingly high in the US as well as in Europe already prior to the pandemic. Constantly growing inequality decreases social cohesion, having a detrimental effect on economic growth as well as the general welfare of the population. Euro area governments, including in Latvia, where the inequality levels are among the highest in the euro area, should address the crisis in a way that is easing the social tensions and ensuring sustainable future growth.
The EC projects that the average government debt-to-GDP ratio in the euro area will exceed 100% this year (Chart 4). This is a significant increase as compared to 89% of GDP in 2019. The rise is, of course, attributable to the sizeable fiscal support measures implemented by the governments to protect the European economies from sliding into a deep crisis. These measures were successful: in the second quarter of 2020, during the highest surge of the pandemic, employment only contracted by 3%. For comparison: in the absence of equally massive employee support measures, employment in the US went down by 15% in the same period. Currently, the European economy is making a strong comeback: the euro area's economy is projected to grow by 4.6% this year.
With the economic fallout from the pandemic fading and the domestic economic activity returning to the pre-pandemic levels, which, according to the ECB's projections, in the euro area could happen already towards the end of the year, efforts to limit the government spending and return to a balanced fiscal policy will have to restart.
Currently, when the monetary policies of central banks are sustaining highly favourable financing conditions, it is very important for the governments to move from the broad and very expensive support provided to all population groups and businesses to much more targeted measures for firms and individuals facing the long-term consequences of the pandemic, for example, in tourism-related sectors.
Strong growth across the euro area is an important pre-requisite for reducing the debt sustainability risks. To this end, the euro area countries and other European Union member states can benefit from the assistance provided by the NextGenerationEU recovery instrument. This funding could be used on reforms to ensure stronger and more sustainable future growth of the economies.
Chart 4. Euro area government debt levels in 2019 and projections for 2021, % of GDP
Source: European Commission.
The pandemic has undoubtedly affected the whole population of the euro area, and the policies pursued by the European governments have helped to significantly cushion the impact. Now that we are gradually emerging from the crisis, it is important to be aware of its long-term economic scars, so that we can limit the potential future shocks to the population.
 Subsector data | European Commission (europa.eu)
 Ability to work from home: evidence from two surveys and implications for the labor market in the COVID-19 pandemic : Monthly Labor Review: U.S. Bureau of Labor Statistics (bls.gov)