After second quarter free fall, EU and U.S. economies need fiscal stimulus

Last Thursday, commentators and analysts alike were startled when the Bureau of Economic Analysis of the U.S. Department of Commerce announced that the Gross Domestic Product, after dropping by 1.3 percent in the first quarter, had dropped by 9.5 percent in the second quarter, which meant it had contracted by 32.9 percent on an annualized basis—the amount it would contract if it dropped by 9.5 percent for four consecutive quarters. It was by far the worst quarterly drop in the GDP since the government started releasing quarterly estimates in 1947.

But as bad as the second-quarter contraction of the U.S. economy was, the extent of contraction of the European economy announced the next day by the European Commission was worse—indeed, in most of the largest member states of the EU much worse. On Friday, Eurostat, the statistical office of the European Commission, released its preliminary flash estimate of GDP for the second quarter. It estimated that, after a 5.2 percent drop in the first quarter, Spain’s GDP dropped by 18.5 percent in the second quarter, almost twice as much as the contraction of the American economy. Likewise, in France, GDP, which dropped by 5.9 percent in the first quarter, dropped by 13.8 percent in the second quarter, and in Italy, GDP, which dropped by 5.4 percent in the first quarter, dropped by 12.4 percent in the second quarter. Even in Germany, GDP, which dropped by only 2 percent in the first quarter, dropped by a greater amount—10.1 percent—in the second quarter than it did in the U.S. in the second quarter. And the large second-quarter contraction wasn’t confined to Europe’s largest economies. Thus, in Portugal, GDP, which dropped by 3.8 percent in the first quarter, dropped by 14.1 percent in the second quarter. In Belgium, GDP, which dropped by 3.5 percent in the first quarter, dropped by 12.2 percent in the second quarter. And in Austria, GDP, which dropped by 2.4 percent in the first quarter, dropped by 10.7 percent in the second quarter.

In all of those countries, the second-quarter contraction was greater—in some cases, significantly greater—than the second-quarter contraction in the U.S., which means the annualized rate of the second-quarter contraction in each of those countries was greater than the annualized rate of contraction in the U.S. Thus, the second-quarter contraction in Spain’s GDP was, on an annualized basis, 55.9 percent. In France, it was 44.8 percent. In Italy, it was 41.1 percent. In Portugal, it was 45.6 percent. In Belgium, it was 40.6 percent. And in Austria, it was 36.4 percent. Even in Germany, the second-quarter contraction was equivalent, on an annualized basis, to 34.7 percent, a bit larger than the American contraction. All of which is not to say the U.S. contraction was not severe. It was. But the contraction in much of Europe was even more severe.

The annualized rates of contraction in GDP are, of course, predicated on the assumption that GDP will continue to contract at the same rate over the next three quarters that it contracted in the second quarter. In normal times, that assumption would be doubtful, if only because one might reasonably expect that countercyclical fiscal and monetary policy would be deployed at some point in the next nine months to reverse the contraction and would have at least some success in doing so. And indeed, while the American effort to undertake a fiscal stimulus of a magnitude warranted by the crisis is stalled in partisan and institutional squabbles in Washington and while the EU’s recently-approved €750 billion recovery plan won’t take effect until the Commission raises the funds in the financial markets and its 2021-27 budget is approved and takes effect, it is nevertheless the case that both the U.S. Federal Reserve and the European Central Bank have risen to the occasion—the ECB through its new Pandemic Emergency Purchase Programme (PEPP) under which it will purchase up to €1.35 trillion of private and public securities through next June. And following the five-day marathon European Council meeting two weeks ago, the Commission will soon embark on borrowing €750 billion and distributing the funds through its budget as grants or loans to assist the member states in recovering from the pandemic. Nevertheless, these are not normal times and it’s not at all clear, given the second surge in Coronavirus infections in the U.S. from mid-June through July and the increased number of infections in Spain, Belgium, France and elsewhere in the EU, and the possible need for a second wave of lockdowns, that the American and European economies will start to recover from the economic consequences of the pandemic anytime soon. To the extent that the recoveries are delayed, or even reversed, in those and other countries, the annualized rates of contraction may, notwithstanding their hypothetical premise, be useful indicators of the magnitude of the economic crisis still facing the U.S. and the EU.

But whether or not the American and European economies continue to contract over the next three quarters at the same rate they contracted in the second quarter, there can be no doubt that they have already experienced significant contractions of their GDP. Even if the U.S. economy doesn’t contract by 32.9 percent, as it would if it contracted for the next three quarters at the same rate it contracted in the second quarter, it nevertheless has already contracted by 10.7 percent in the first six months of the year. Meanwhile, although the EU estimated last month in its Summer Interim Economic Forecast that the euro area would experience a contraction of 8.7 percent this year, a slightly larger contraction than the 7.7 percent contraction it had forecast in its Spring Forecast in early May, last week’s flash estimate indicated the euro area has already experienced a substantially greater contraction of 15.3 percent in the first six months of 2020. And whereas the EU forecast in the Spring that the Spanish economy would contract this year by 9.4 percent and subsequently increased that slightly to 10.9 per cent in last month’s Summer Forecast, last week’s flash estimate indicated the Spanish economy had contracted by 22.7 percent in the first six months of 2020. Likewise, the French economy, which the Commission estimated in its Spring Forecast would contract by 8.2 percent—a figure it subsequently raised to 10.6 percent in its Summer Forecast—actually contracted by 18.9 percent in the first six months of the year. The Italian economy, which the Commission estimated in its Spring Forecast would contract by 9.5 percent—a figure it subsequently raised to 11.2 percent in its Summer Forecast – actually contracted by 17.1 percent in the first six months of the year. And the German economy, which the Commission estimated in its Spring Forecast would contract by 6.5 percent—a figure it subsequently lowered to 6.3 percent in its Summer Forecast—has already contracted by 11.9 percent in the first half of 2020.

The point is not to fault the Commission for systematically underestimating the extent to which the European economy has contracted this year, although it did indeed underestimate the extent of the contraction in its May and July forecasts. Rather, the point is to underscore the magnitude of the contraction that has already occurred this year and the urgent need for the EU and its member states to undertake a substantial fiscal stimulus. And as in the U.S., it needs to do that now; it can’t wait for the Commission to go to the markets, raise the funds for its recovery program, and then, sometime in 2021 after the member states have submitted plans for review, start providing grants and loans on a piecemeal basis to the member states. The time to act is now.

David R. Cameron is a professor of political science and the director of the MacMillan Center’s European Union Studies Program.