Sharp economic slowdown warrants better protection of the EU’s most vulnerable people

The European Union’s economy has weathered three years of tumult, starting with the COVID-19 pandemic and followed by the spillovers from Russia’s invasion of Ukraine. Although growth in the EU27 fared far better than initially expected in 2022 — with output expanding at a robust pace of 3.5% due to additional fiscal support and earlier strength in domestic demand — this resilience has since faded, according to the latest World Bank ‘EU Regular Economic Report’.

The near-term outlook appears challenging, owing to persistent inflation, macroeconomic policy normalisation and a feeble global environment amid tighter financing conditions, weak trade, high uncertainty and tepid external demand. These drags to economic activity have repercussions for vulnerable households, making them susceptible to additional negative shocks.

Following years of low and stable inflation, euro area inflation has overshot the European Central Bank’s 2% target since late 2021. Consequently, high inflation has led to one of the most pronounced monetary policy tightening cycles in recent years (see FIGURE ES.1 a in the report.). The acceleration in inflation was driven in part by the release of pent-up demand after economic reopening from lockdowns, pandemic-related supply bottlenecks and a surge in commodity prices and supply disruptions from Russia’s invasion of Ukraine (see FIGURE ES.1 b in the report.). While inflation has been showing recent signs of easing across many EU countries, it nevertheless remains high, especially in some of the poorer EU economies. Despite ongoing fiscal support, the adverse impact of high inflation on real disposable income has disproportionately affected the region’s poorest.

Economic activity in the EU is likely to be further dampened by soft external demand alongside weak growth in large economic partners. The slowdown in global trade has exacerbated the downturn in Europe’s manufacturing sector. The rapid tightening in global financing conditions — reflecting policy rate hikes to combat high inflation, as well as high uncertainty and weak confidence after multiple shocks — has contributed to recent banking sector and financial market volatility. As a result, credit has substantially tightened in the EU.

Going forward, EU countries will need to restore their macroeconomic policy buffers. To this end, policymakers must carefully scale back the sizable fiscal support that was put in place to confront several crises since 2020, while ensuring that the most vulnerable people are adequately supported. To balance these competing priorities, member states, particularly in the less affluent central eastern European countries, will need to better target fiscal support to the poorest and most vulnerable people, or else these households risk falling further into poverty.

The strong macroeconomic rebound in 2022 masked considerable unevenness among the EU’s population. Although the recovery in employment was remarkably strong in 2022, many have been consistently left behind: youth, lower-educated and blue-collar workers. The youngest workers — those aged 15 to 24 years old — have experienced much higher employment losses (see Figure 2.1 a in the report.), partially due to the lower availability of part-time jobs. Lower-educated workers faced the most significant employment contraction during the pandemic at 10%, compared to 4% for an average worker, with considerable regional variation across the EU; those in central eastern Europe have lagged especially far behind. Employment levels of blue-collar workers, regardless of their skill level, have not returned to pre-pandemic levels (see Figure 2.1 c in the report.).

EU member states have so far provided timely but largely untargeted support, such as government price caps on food and energy to shield households and businesses from price hikes. However, a large share of this support has accrued to the better-off households in higher income quintiles.

What is needed is fiscal support that is carefully targeted towards those most in need, both businesses and households. Strengthening the social protection system to deliver adequate aid to targeted households is critical. Ensuring minimum wage adequacy, particularly with respect to the ratio of the minimum wage to the cost of basic food baskets, is also essential.

Our latest data shows that households at the lowest end of the income distribution spent more than half their total budget on food and energy – a much larger share than their peers in higher income brackets. And while increasing prices impact all households, there has been a recent widening of the inflation gap between wealthier and poorer households.

The indirect effects of energy price increases through core inflation have had a pronounced negative impact. For example, poverty rates (using the $6.85 international poverty line) are estimated to have increased by up to 1.8 and 1.7 percentage points in Bulgaria and Romania, respectively.

Governments have competing demands, especially in these challenging times, and need to ensure a well-calibrated macroeconomic policy mix so that fiscal policy does not contribute to further inflationary pressures. However, identifying and prioritising vulnerable groups of people with targeted, timely, time-bound and transparent support can help mitigate this risk, and it is also much more efficient and cost-effective.

The views expressed in this #CriticalThinking article reflect those of the author(s) and not of Friends of Europe.