The global economy will shrink this year more than ever in the last 75 years as a result of the covid-19 pandemic. Growth first dropped in China, where the epidemic originated and strong lockdown measures were implemented to contain the virus. A little later, viral infections also spread to Europe and the United States, where the economies had to be shut down extensively to curb the epidemic. The markets first saw complete panic in the form of a stock market crash and credit market tightening, but the situation was calmed during the spring by a strong monetary and fiscal stimulus in developed economies. The U.S. Federal Reserve cut its key interest rate to zero in mid-March. All Western central banks embarked on extensive securities purchase programmes to increase liquidity.
The U.S. economy is forecast to contract by 6.3 per cent this year. The country’s GDP fell 9.1 per cent in April-June from the previous quarter, but it has subsequently begun to recover. For next year we forecast U.S. growth will be 4.8 per cent. Economic growth will be supported by the Fed’s interest rate cuts and securities purchase programme, as well as federal support programmes during the coronavirus crisis. The general stance of the trade policy in the United States is expected to continue to be protectionist regardless of whether Trump is elected for a second term or whether a Democratic president is inaugurated next year. It will nevertheless be easier to resolve trade disputes if Trump is not elected for another term.
Etla forecasts that euro area GDP will contract by 7.6 per cent this year but grow by 5.5 per cent in 2021. German GDP will contract less this year than the euro area economies on average, but it will grow at a slower pace next year. The countries of southern Europe, for which tourism is an important industry, have been hit hardest by the corona crisis. China’s economy is forecast to grow this year after a sharp contraction of 1 per cent in the early part of the year. Positive growth is a relatively good achievement, but at the same time far below the 6 per cent target set by the central government. Next year, we expect growth in China to rise to 8 per cent as the coronavirus pandemic no longer significantly curbs the country’s economic growth.
This year total global output is expected to fall by 4.4 per cent. The last time the world economy contracted this strongly was in 1945. World economic growth is forecast to accelerate to 5.4 per cent next year.
The biggest risk to the realization of our forecast is an uncontrollable re-emergence of the coronavirus pandemic in Europe, leading to widespread economic lockdown measures as happened in the spring. In addition, the Economic Policy Uncertainty Index for the United States is now higher than ever during its measurement history starting in 1985. The truce in the U.S.-China trade war will bring some relief to world trade, but the trade war could also escalate again next year if Trump is elected. In Europe, on the other hand, the risks are increased by a no-deal Brexit, the realization of which is already somewhat likely at the beginning of next year.
It is also good to remember that tariffs between the United States and China have risen significantly since 2018 and it appears the increases will remain in place for some time. The average tariff level applied by the United States to Chinese imports has risen from 3.1 per cent in early 2018 to 19.3 per cent by March this year. China’s tariffs on imports from the United States, on the other hand, have risen from an average of 8 per cent to 20.3 per cent. This also reduces the growth potential of the global economy over the forecast horizon.
Total output in the euro area collapsed by as much as 12.1 per cent this spring from the previous quarter, as the epidemic had to be curbed by extensive lockdown measures and restrictions. In the second quarter, the Spanish economy contracted by as much as 18.5 per cent from the previous quarter while the German economy shrank by 9.7 per cent from the previous quarter.
The fall in the GDP of the euro area is the result of the decrease in the GDP of all its member states this year. The pandemic nevertheless affects countries unequally. The steepest economic declines are occurring in southern European countries, especially Spain and Italy, both of which also saw a significant number of coronavirus deaths during the spring. Southern European countries are suffering from the almost complete curtailment of tourism during the pandemic. According to our forecast, the German economy will contract by around 6 per cent this year, which is slightly less than the euro area average. Germany managed to curb the epidemic more effectively than many other populous European countries, but suffered during the spring, for example, from component availability problems in the automotive industry.
For the year as a whole, we forecast a contraction in the euro area’s economy by 7.6 per cent. Next year, growth will recover to 5.5 per cent as the coronavirus pandemic begins to slowly subside.
The economies of Spain and Italy will shrink by about a tenth this year. The GDP of the Netherlands and Austria is falling at roughly the euro area average speed, hence they are performing slightly better than that of France’s. The euro area will nevertheless receive crisis aid this year from unprecedented expansionary fiscal policies and the EUR 750 billion stimulus package agreed by EU countries in July, with EUR 390 billion in direct aid and EUR 360 billion in the form of loans. Highly indebted southern European countries in particular will benefit from the agreed package. At the same time, the EU is taking a step towards fiscal union.
Euro area monetary policy eased in the spring as the ECB launched a massive securities purchase programme to increase liquidity during the pandemic. The size of the programme was initially announced to be EUR 750 billion, but it was increased to EUR 1 350 billion in June. The ECB also seeks to alleviate the credit crunch problems of small and medium-sized enterprises through targeted financing operations. The deposit rate will remain at -0.5 per cent and the key interest rate at zero until at least the end of 2022.
Uncertainty for European economies also continues to be caused by the Britain’s withdrawal from the EU. Britain and the EU countries are currently negotiating permanent trade relations that would take effect after Britain’s transition period. Achieving an agreement does not seem very likely at the moment in the current tight schedule, so there is a danger that trade relations will end up with a no-deal outcome early next year. This would create an unnecessary negative shock to foreign trade in an otherwise challenging situation.
Finland’s GDP contracted by 4.5 per cent in April-June from the previous quarter and by 6.4 per cent compared to the same quarter last year in the most difficult phase of the corona crisis. Private consumption fell sharply, by 10.9 per cent year-on-year. Investment decreased by 1.2 per cent in the second quarter, exports by 12.0 per cent and imports by 12.7 per cent year-on-year. Public consumption also decreased by 0.9 per cent year-on-year.
We forecast that Finland’s GDP will shrink by 4.5 per cent this year. The growth forecast has thus been raised by 3.5 percentage points from the update of our forecast published in May in connection with our industrial outlook. The upward revision of the growth figure is due to the fact that the epidemic has remained more subdued in Finland than expected. International demand is also recovering faster than expected in the spring. Both domestic and foreign demand will cut GDP growth this year. We forecast 3.2 per cent economic growth next year. Growth will be boosted next year above all by private consumption, while net exports will still have a negative impact on growth.
According to our forecast, exports will shrink by about 12 per cent this year but they will grow by 5.5 per cent next year. Investment will decrease by 3.4 per cent this year but grow slightly next year. Private consumption is forecast to fall by 5.4 per cent this year but rebound by 4 per cent next year. In 2022 we expect Finland’s GDP to grow by 1.9 per cent, which is slightly faster than our potential output growth rate.
According to the European Commission’s spring estimate, production would be below potential output by an average of 5.4 per cent in 2020 and by 3.1 per cent in 2021. Etla’s assessment is somewhat more positive, however, than the European Commission’s May 2020 forecast. The slightly better-than-expected development of the economy after the spring explains the differences.
It is very likely that estimates of the output gap will continue to change sharply as the crisis progresses. There is a great deal of uncertainty associated with both the economic outlook and the assessment of the economic situation, especially at turning points in economic cycles.
We forecast that the volume of exports will shrink by 11.9 per cent this year. Exports of goods will fall by 8.3 per cent, but exports of services will drop even more sharply by 18.9 per cent. The weakness of service exports is explained by the decline in foreign tourist visits to practically zero since the spring. Similarly, transportation services will decrease sharply this year. The corona pandemic is a severe setback for the Finnish shipbuilding industry. Global demand for cruise trips has stalled and it is therefore unclear whether all large cruise ships in the order backlog will be delivered on schedule. In addition to the corona crisis, the decline in merchandise exports this year will be affected by the forest industry strike at the beginning of the year and the end of large gas pipeline deliveries. On the other hand, the contract manufacturing of cars and their export is getting new wind in its sails.
Next year, the volume of exports is forecast to recover by 5.5 per cent, as exports will benefit from the recovery of the international economy and world trade. Exports of services are forecast to grow at a rate of 8.6 per cent. In 2022, total export growth will slow down only slightly from the previous year, to 5.2 per cent. Continued export success will require that the increase in earnings, taking into account productivity developments, does not significantly exceed the growth rate of earnings in competitor countries in 2020–2022. According to our estimates, Finland’s price competitiveness will remain almost unchanged in 2020–2021. Our projections in this forecasting round nevertheless involve an exceptional amount of uncertainty.
Investment is forecast to shrink by 3.4 per cent this year. The decline is due to a significant fall in investment in machinery and equipment. The drop is the result of overcapacity, economic uncertainty and a clear drop in export demand this year. Residential construction is projected to subside by 1 per cent this year. Public investment will compensate for the weakness of private investment. The projections for construction have nevertheless been raised compared to the spring.
In 2021, investment will return to slow growth of 0.7 per cent. Residential construction will nevertheless still shrink slightly next year. We forecast that non-residential construction, on the other hand, will increase by almost one and a half per cent. The growth of productive investment is accelerated by the government’s decision to double the right to depreciate machinery and equipment purchases. Infrastructure construction and R&D investment will also grow faster than GDP over the forecast period.
Last year’s employment growth was faster than expected. At the same time, the unemployment rate also fell to 6.7 per cent. The number of employed is nevertheless forecast to fall sharply this year, by around 57,000. The number of public sector jobs, however, is increasing. As the labour force is expected to shrink by about 20,000 people, the unemployment rate will rise moderately to 8.1 per cent. The employment rate will thus fall to an average of 71.2 per cent this year.
Next year employment will return to slow growth. The unemployment rate will fall to 7.9 per cent. Labour market participation will increase after the crisis year, so the labour force will also increase slightly, by 0.3 per cent. The employment rate is expected to improve to 71.7 per cent next year. Indeed, the employment rate may increase due to a small increase in employment, as the number of people aged 15-64 is still projected to decline. At present, employment growth is constrained by weak labour demand, but labour supply will start to constrain employment growth again at the end of the forecast period.
We forecast that the employment rate will rise to 72.7 per cent by 2023. The 75 per cent employment rate target of Prime Minister Marin’s government will therefore not to be achieved unless new, very significant employment measures are taken.
The coronavirus and the restrictions that it causes will clearly cut private consumption this year. Private consumption is forecast to shrink by as much as 5.4 per cent this year. At the same time, the combined savings rate of households and non-profit institutions serving households will rise to well over 5 per cent. It is essential for the development of private consumption that the covid-19 epidemic will remain under control in Finland in the future. Based on this assumption, we forecast private consumption will grow by 4.0 per cent next year.
In 2022, private consumption is projected to grow by 1.9 per cent as earnings and employment developments continue to bolster consumption and the recovery from the pandemic continues. According to our forecast, the earnings level will rise by 1.8 per cent this year and by 2.3 per cent next year. We forecast an increase of 2.1 per cent in earnings in 2022.
Consumer prices are forecast to rise by only 0.5 per cent this year. Inflation will be dampened this year by the sharp fall in energy prices in particular. Inflation is being fuelled by rising prices for housing, food and tobacco products. Next year, the rise in consumer prices will accelerate slightly to 1.3 per cent, boosted by price developments of the same consumer items as this year as well as by rising prices for transport, health services and restaurant and hotel services (although food prices will spur inflation more this year). In 2022 consumer prices will rise by 1.2 per cent in our forecast.
The general government deficit will widen sharply over the forecast horizon. Last year, the public sector deficit was still 1.1 per cent of GDP. Discretionary-based fiscal policy was expansionary even before the corona crisis. The corona crisis and the public subsidies planned to overcome it will significantly increase this year’s deficit. We therefore forecast a budget deficit of 7.8 per cent of GDP for this year and a deficit of 5.0 per cent of GDP for next year. The balance of public finances is thus deteriorating, on the one hand, due to the contraction of GDP but also due to discretionary expenditure increases.
The general government EDP debt will rise to 70.7 per cent in our forecast for this year. We project the general government EDP debt will reach 72.6 per cent next year and 73.7 per cent in 2022. In our baseline forecast, the general government EDP debt will still increase at the end of the forecast period and will already reach 78.0 per cent of GDP by 2024. The central government’s budget balance will also deteriorate in the forecast years. The surplus of social security funds will shrink from 1.4 per cent last year to 0.7 per cent of GDP by 2024. Our expectations for the future development of the government debt-to-GDP ratio have improved slightly compared to the May forecast. The actual development is very sensitive, however, to changes in the value of GDP. There are also big questions about whether the current government will be able to implement measures to raise the employment rate. Another question is how expensive such measures would be for public finances.
The structural budget balance is estimated to have deteriorated very sharply in 2020. Starting from a level of -1.7 per cent of GDP in 2019, it is projected to reach around -5.5 per cent in 2020. As early as 2021, the structural balance is expected to be around -3.8 per cent.
As a result of the exceptional economic circumstances spawned by the coronavirus, the European Union has introduced a general exemption clause in EU fiscal rules. On this basis, the rules do not currently limit the immediate response of member states to the crisis.
In the medium term, rule-based fiscal policy will in any case be reactivated. Based on the weak debt and deficit development in Etla’s public finance forecast, it is quite clear that Finland needs to adjust its fiscal policy in the medium term in order to avoid a breach of the rules.