Euro-zone incomes will be hit harder than US - Capital Economics
Global Economics

Euro-zone incomes will be hit harder than US

Global Economics Update
Written by Gabriella Dickens

On the face of it, the surge in unemployment in the US implies that households are being hit harder by the crisis than those in Europe. But much of this reflects differences in the way that furloughed workers are being treated in the data. Taking this and other factors into account, we expect household incomes and consumer spending to fall much further in Europe than the US.

  • On the face of it, the surge in unemployment in the US implies that households are being hit harder by the crisis than those in Europe. But much of this reflects differences in the way that furloughed workers are being treated in the data. Taking this and other factors into account, we expect household incomes and consumer spending to fall much further in Europe than the US.
  • The coronavirus has had a huge impact on labour markets across the globe, but some countries appear to be faring worse than others. (See Chart 1.) So far, Japan’s labour market seems to have held up fairly well – the unemployment rate edged up from 2.5% in March to just 2.6% in April. And it was a similar story in the euro-zone where the jobless rate rose from 7.1% to just 7.3% in April. In contrast, the US has been hit very hard. The official unemployment rate surged from 4.4% to a staggering 14.7% – far worse than the increase experienced during the global financial crisis. And the BLS revealed that given that some people were misclassified as employed, the true unemployment rate would have been closer to 20%.
  • April data for the UK are yet to be released, but early evidence suggests that the jobless rates there will rise less than in the US. Indeed, the rise in the claimant count measure from 1.2 million to 2.1 million in April suggests that the unemployment rate increased from 3.9% in March to over 5.5% in April.
  • One explanation for this disparate performance is the variation in job retention schemes. The US has implemented the Paycheck Protection Program (PPP) consisting of $750bn of small business loans, forgivable if firms keep workers on the payroll. But the scheme came too late to prevent the initial wave of layoffs and is less generous than the outright grants offered elsewhere.
  • The schemes have been more effective at limiting the rise in unemployment in the UK, the euro-zone and Japan. In the euro-zone, over a quarter of the workforce is signed up to wage subsidy schemes, though the take-up varies between countries. Meanwhile, Japan has expanded its employment adjustment scheme introduced during the financial crisis. This has so far proved effective with a record 5.97mn people officially counted as employed but not actually working in April. In the UK, the government’s furlough and self-employed schemes are paying the wages of over 11 million people. If these workers had been laid off, the unemployment rate would have risen to over 30%. We expect unemployment rates to roughly double at their peak in the UK, the euro-zone and Japan, while in the US the rate has already more than tripled.
  • However, there are two reasons why the US experience may not be as different to the other G4 economies as it first appears. First, according to the household survey, 78% of all those unemployed are on temporary layoffs, meaning that they expect to return to work within the next six months. They might not all do so – indeed, we assume that only two thirds of them will return to work over that period. But the same could be said of furloughed workers under job retention schemes. Governments could just be kicking the can down the road with a second round of job losses likely once these schemes start to be withdrawn.

Chart 1: Official Unemployment Rates (%)

Chart 2: Official Unemployment Rate Forecasts (%)

Sources: Refinitiv, Capital Economics

  • Over the coming months, we expect the unemployment rate to peak in May at 22.5% in the US before dropping back fairly quickly to around 6% by the end of the year as lockdown measures are lifted (See Chart 2.) Meanwhile, in the UK and the euro-zone unemployment seems likely to rise further in the months ahead. And given the likelihood of a long-term hit to economies in the euro-zone in particular, unemployment rates will still be much higher than those in the US and further above their pre-crisis levels by the end of 2021. In Japan, the effectiveness of the job retention scheme coupled with a reluctance among firms to fire workers means the hit to unemployment will feed through in drips, roughly doubling the rate to a still low 4% or so by the end of the year.
  • Second, the hit to incomes, which are of most relevance to economic performance, may be greater in the euro-zone and the UK than in the US. After all, the US Government has expanded unemployment benefits by around $600 per week. Given that most of the jobs lost were in the hospitality and leisure sectors where the average wage is $400 a week, many are actually better off than they were pre-virus. (See Chart 3.) Meanwhile, workers signed up to wage subsidy schemes in the UK and euro-zone will be worse off given that they will be paid a maximum of 80% of their monthly earnings by their respective governments.
  • Taking into account our unemployment forecasts, generosity of state support and the differences in economic performance which will influence the extent of pay rises (or cuts) for those in employment, Chart 4 shows our forecasts for real disposable incomes growth in the major advanced economies. The biggest hit will come in Italy and Spain, where a recovery in 2021 will fail to reverse this year’s slump. Belying the dire unemployment data, US household incomes growth looks set to suffer relatively little.
  • These forecasts underlie our expectation that the euro-zone and the UK will see much steeper declines in consumer spending than Japan or the US this year.

Chart 3: US Average Weekly Earnings by Industry

Chart 4: Real Household Disposable Income (% y/y)

Sources: Refinitiv, BLS, Capital Economics


Gabriella Dickens, Assistant Economist, gabriella.dickens@capitaleconomics.com