Uncertainties in the external economic environment against the backdrop of the coronavirus crisis
(authors: Soňa Benecká, Martin Kábrt, Luboš Komárek, Filip Novotný, Petr Polák, Michaela Ryšavá)
Long-term uncertainties and risks persist in the external environment against the backdrop of the COVID-19 pandemic. These are fostering higher price pressures and lower economic growth in the long run. They include above all Brexit, trade wars, deglobalisation and new environmental measures.
The transitional period for the trade arrangements between the EU and the UK will end in December 2020. Unless a trade agreement is signed, customs checks and tariffs under the general rules of the World Trade Organisation will be introduced between the EU and the UK on 1 January 2021. Numerous rounds of negotiations between EU and UK representatives have failed to make tangible progress so far. The main sticking points include a level playing field for competition (especially in the field of state aid), supervision of compliance with agreements, and fishing rights in British waters. The situation has also been unfavourably affected by a draft UK internal market bill, which could eliminate the legal force of part[1] of the Brexit deal ratified last year.
The EU summit in mid-October stated that progress in the talks was still not sufficient for the planned trade deal with the UK to be reached. October is considered the deadline for reaching an agreement. It is generally expected that a Brexit with no agreement on long-term bilateral trade relations would adversely affect investment and mutual trade, which has already been hit by four years of uncertainty since the Brexit referendum (see Chart 1). Studies[2] indicate that goods trade between the EU and the UK would drop significantly without a deal. The independent National Institute of Economic and Social Research (NIESR) projects a fall of 50%–60% and foresees a similar drop in services trade. The UK government has estimated the total decline in trade between the UK and the EU at 37%. This would adversely affect economic growth in both territories, but the impacts on the UK would be greater. Germany – the Czech Republic’s biggest trading partner – would be the hardest hit country in the EU. The CNB’s estimates indicate that the impacts on the Czech economy would not be negligible either.[3] From the sectoral perspective, the adverse effect on the automotive industry would be particularly strong.
Chart 1 (BOX) Share of exports from the EU27 to the UK in total exports from the EU27
The share of exports from the EU27 to the UK in total exports from the EU27 has been falling in recent years
(percentages; three-month moving average; source: Eurostat)
Note: The vertical line denotes the Brexit referendum (23 June 2016).
There are continuing trade tensions between the USA and China and between the USA and Europe. Although the phase one trade deal of January 2020 is holding, President Trump stated in July that he saw a phase two deal as unlikely. The main disagreements now concern technology. Restrictions in this area could slow global technological progress. The US government is seeking to ban the activities of several Chinese firms (ByteDance – TikTok, WeChat and Huawei) in the US market. In September, moreover, it restricted US supplies to Chinese chip makers (SMIC) on grounds of national security. The rising mistrust is reflected in rapidly shrinking capital flows between the two countries (see Chart 2). The outcome of the US election in November will probably affect the dynamics and specific areas of trade and political disputes but is unlikely to significantly change the overall course of US–China relations. In addition, there is uncertainty regarding trade relations between the USA and Europe, especially in the digital taxation area. The discussed – and in some countries already introduced[4] – digital tax has major implications for US firms. The retaliatory measures being considered by the USA are broader in nature and could include customs barriers.
Chart 2 (BOX) Mutual investment between the USA and China
The volume of investment between the two countries has been falling since 2018 and hit a nine-year low in 2020 H1
(USD billions; source: US-China Investment Hub)
The drive towards green energy, and especially the pressure to cut greenhouse gas emissions, is another burden on EU economies. In early September 2020, the European Parliament passed a stricter emissions reduction proposal than planned by the Commission. Emissions are to be reduced by at least 55% by 2030 compared with 1990 levels. The decarbonisation of human activities will require a fundamental transformation of entire economies, from heat generation through to car production. These structural changes will have to be supported by a green fiscal stimulus, managed progressively by increasing carbon prices and by making compensation transfers to poor households. These efforts will clearly put a burden on European industry. However, the additional cost shock of the higher carbon tax may be offset by green R&D subsidies and by the benefits of firms’ innovation activities.
The new environmental requirements affect the automotive industry above all. After the outbreak of the pandemic, Europe recorded the lowest new car sales in decades (see Chart 3). Moreover, according to recently approved EU regulations, automakers will soon face higher costs in the form of penalties for making insufficiently green cars. The demand situation is little better. This is due to the high price elasticity of demand for cars relative to other goods, the very high car ownership rates among households and firms in key markets (especially Germany), and above all to the general economic uncertainty going forward. Provided that the second wave of the pandemic does not involve long shutdowns of the economy and the situation soon improves, the pandemic might spur innovation. Fiscal stimuli are also likely to be directed at supporting green policy. In June, the German government approved a fiscal stimulus targeted primarily at electromobility, while a scrapping fee for combustion engines was repeatedly rejected. France has also moved in this direction.
Chart 3 (BOX) Car registrations in the EU
The coronavirus crisis caused the largest fall in new car registrations
(annual percentage changes; three-month moving average; source: European Automobile Manufacturers’ Association)
[1] Specifically the Protocol on Ireland and Northern Ireland, the main goal of which is to avoid a hard border between Ireland and Northern Ireland and safeguard the all-island economy.
[2] Hantzsche, A. (2019): Briefing: Industry and regional effects of a no-deal Brexit, National Institute of Economic and Social Research, 12 September 2019.
HM Government (2018): EU exit: Long-term economic analysis. November 2018.
[3] See the disorderly Brexit scenario in IR IV/2019.
[4] https://crsreports.congress.gov/product/pdf/IF/IF11564