Why Europe's in Better Shape Than the U.S.

(Bloomberg Opinion) -- After the great recession, the American economy rebounded faster and stronger than the euro zone, raising doubts over the effectiveness of the “European social model.” As Europe emerges from the first wave of the Covid-19 epidemic in better shape than the U.S., its combination of welfare states and strong public health systems suddenly seems appealing again.

The U.S. is still struggling to contain outbreaks in several states from Texas to Florida, whose health-care systems are being pushed to the brink. The federal government has failed to articulate a unified message for the country, as state governors have taken conflicting decisions on the length and strictness of their lockdowns.

Meanwhile, in most European countries, the situation appears under control. From Germany to Greece, countries are dealing with a handful of flare-ups, but they're being contained by localized restrictions. Governments have reopened their economies steadily, without causing a new surge of infections. The sacrifices of months of lockdown appear to be paying off for now.

Europe's economy also appears to be improving. The euro zone is in the middle of a very steep recession, and the European Commission expects the bloc's gross domestic product to fall by nearly 8% in 2020. The difficulties in other parts of the world in managing the pandemic will weigh on exports — and especially on tourism. But restaurants, bars and shops don't seem to be heading for a mass round of fresh lockdowns, unlike in the U.S. Domestic demand, from consumers and governments, should keep recovering as long as the pandemic is kept in check.

Europe's labor market institutions are cushioning the blow. Countries from Germany and France to Italy and the U.K. have generous furlough schemes, where governments are subsidizing workers for the hours they're not employed. Companies can keep more employees on their payroll without triggering a downward spiral of unemployment and falling demand. As the economy restarts, businesses aren't having to go through the long and costly process of rehiring workers. The biggest problem for Europe will be making sure this doesn't turn into never-ending life support for unviable companies and industries.

The experience of the euro zone and U.S. labor markets since the pandemic shows the difference of the two approaches. The U.S. unemployment rate stood at 11.1% in June, up from 3.5% in February. The actual number was probably worse. Jason Furman and Wilson Powell III at the Peterson Institute of International Economy believe the “realistic unemployment rate” was 13% in June, correcting for misclassification errors. The data don't take into account the worsening medical crisis in the second half of June, which has prompted a number of states to reverse their reopening plans. The euro area unemployment rate has risen much less: It climbed to 7.4% in May, up from 7.2% in February.

This divergence is the result of the euro zone's use of furlough schemes, which have covered more than 35 million people in the bloc's five largest economies. A group of economists at the European Central Bank found that these salary-support programs buffered the impact of the epidemic on households' disposable income. In the absence of these benefits, the drop of worker income across the euro area would have been 22% during the lockdowns. Thanks to the governments' measures, it was only 7% — although there were differences between member states, with Germans receiving the most help.

The problem for Europe is that these schemes are very expensive and provide perverse incentives for companies and workers, who may be in no hurry to return to the their jobs. Employers will still need to adapt to the new economic reality post-Covid, whether that's downsizing to reflect lower demand or changing their business models. The longer the furloughs last, the more this process will be delayed. That's especially true in countries such as Italy, which have banned companies from firing workers.

This doesn't mean furloughing is a bad idea. But governments need to accompany them with active labor market policies, such as retraining those who are likely to become unemployed. In the past, these areas of spending have been neglected in those countries that have been worst affected by the crisis, such as Italy and Spain. Their reopenings might be especially tough.

The euro zone deserves two cheers for its health-care and labor institutions, which have helped it to weather the pandemic better than the U.S. However, it needs to ensure it doesn't merely prop up zombie companies. Freezing the jobs market makes sense in the short term, but it's not a viable long-term strategy.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Ferdinando Giugliano writes columns and editorials on European economics for Bloomberg View. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.

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