Long-term effects of Covid-19: a growth accounting approach

The effect of the pa n demic on the euro area economy is likely to be felt for a long time and well past the point when a vaccine has been approved and governments will have lifted all containment measures. We see three channels through which the pandemic may “ scar ” the economy. First, higher corporate leverage and a perception of heightened uncertainty may slow investment spending independent on the overall cyclical outlook. Second, a rise in “zombie” firms may weigh on productivity growth. And finally, school and university closures will have reduced educational attainment for the generations entering the labour market in the coming years . We employ a so-called growth accounting approach in order to get a rough idea about the size of each factor in pushing trend growth in the EMU4 countries down. More specifically, we construct a “ lower bound ” scenario in which we assume a significant adverse effect from the pandemic. French and Spanish trend growth would converge in this scenario to zero by 2025 , while German trend growth would turn negative. Trend growth in Italy would even become significantly depressed . Beyond the negative effect from the pandemic , these results also reflect the challenging demographics, in particular in Germany , Italy and Spain . Our simulations suggest that the medium-term growth outlook for Europe may be grim. What our simulations therefore also show is the need to enact structural reforms to counter these effects. The Next Generation EU fund provides a good opportunity to start this process in earnest.