Excessive Adherence to Crisis Policies Fosters Zombification of the Economy

As the COVID-19 crisis slowly abates, the EU Member States are now confronted with a new economic crisis as a result of the war in Ukraine. The rapid succession of crises reinforces the need to respond with highly targeted and temporary aid measures to avoid wasting public resources and preserve fiscal buffers. Against this background, a new study by ZEW Mannheim for the European Parliament has examined which Member States have pursued insufficiently targeted policy measures to cushion the pandemic crisis over the past two years and have remained in crisis mode for too long despite economic recovery. Italy, France and Greece in particular have been too slow in scaling down their aid measures. In the case of Germany, the study criticises in particular that the government has adhered to the very generous short-time work rules for too long.

The study stresses that the vigorous fiscal response at the beginning of the pandemic in 2020 was in principle appropriate. However, when comparing the size of the initial aid packages between EU states, it becomes clear that some of them may have been excessive: “The scale of support was exceptionally high in Greece, Italy and Germany. This is also true if you put the size of the aid in relation to the severity of the coronavirus-induced recession,” says Professor Friedrich Heinemann, head of the ZEW Research Department “Corporate Taxation and Public Finance”.

The study argues that two years after the outbreak of the pandemic, the undifferentiated massive aid is no longer appropriate. Based on the experience gained in coping with the pandemic, it is possible to scale back support measures even in recurrent pandemic waves. The analysis also makes clear that several business models will no longer be viable in the ‘new normal’. “It does not make sense to support companies for years when their business model has become obsolete due to the permanent changes brought about by the pandemic. That would lead to a zombification of the economy,” says Friedrich Heinemann.

The analysis quantifies the planned normalisation of public budgets by 2023 and shows that the corrective measures in Italy, France and Greece have been particularly slow. Eastern European states such as Estonia, on the other hand, are characterised by a distinctly quick exit from all crisis measures and can thus avoid an unnecessary build-up of public debt. They are therefore much better prepared than others to cope with the new crisis situation.

The ZEW study also compares the characteristics of credit and short-time work programmes in the pandemic. In the case of government loan guarantees, Spain has a particularly promising strategy because banks there bear a larger share of the default risk, which creates incentives for them to test the viability of business models. In terms of short-time work schemes, Germany stands out negatively because there is a trade-off between protecting businesses and creating false long-term incentives. “Unlike in all other EU Member States, in Germany the wage replacement rate increases with the duration of short-time work. This is likely to lead to far-reaching disincentives and obstacles to structural change. This European comparison provides another important argument to critically question the further extension of the maximum use of short-time work to 28 months recently decided by the German government,” says Friedrich Heinemann.