European consumers after the pandemic

This of course immediately changed when the COVID-19 crisis struck. Private consumption contracted by 8.6 per cent in 2020. A contraction on this scale is unprecedented. In 2009, at the peak of the recession caused by the global financial crisis, the contraction amounted to a comparatively tiny 1.4 per cent.

Looking below the headline figures shows that the patterns we have seen in previous recessions are not of much help when trying to understand the current one. Consumer behaviour during the COVID-19 crisis does not match these templates (figure 2). In fact, consumers behaved in the opposite way. After the initial wave of lockdowns in Europe, spending on consumer durables recovered extremely quickly, yet based on past recessions it would be expected that durable goods would experience the harshest effects and would rebound only after the recession was over.

By comparison, in the COVID-19 recession, non-durable goods contracted, though not dramatically, and began to recover very quickly. For services, the picture looks completely different. They fell further than durable goods in the first phase of the recession and could not recoup their losses. The reason is pretty clear. Government interventions required large parts of the Eurozone’s services sector to close completely. The unusual, swift recovery in durable goods also reflects government interventions through a set of policies that have insulated consumers from the most extreme effects.

The extent to which the COVID-19 crisis affected consumption across countries, therefore, stems from the difference in consumption structures. While in the UK, for example, 21 per cent of consumer spending is spent on so-called socially consumed services, such as meals out, leisure activities and holidays – the areas most affected by lockdown measures – in Germany, this share represents only around 16 per cent. The fall in UK consumption was consequently more severe compared to Germany.

Policy interventions cushion labour markets

Disposable income in the European Union and United Kingdom fell substantially during the initial outbreak of the COVID-19 crisis in the first quarter of 2020 but recovered in the following quarters. This was thanks to unprecedented fiscal, monetary and labour market measures implemented by governments to limit the impact of the novel coronavirus on the economy.

One of the key measures used to stabilise European labour markets was the introduction of short-term work or furlough schemes. These schemes were intended to protect the labour market, covering the cost of workers with government money so that employers dealing with the downturn did not have to sack them. In this way, employees could be compensated for lost income by government transfers and keep their jobs, which might otherwise have been lost, and recovery once economies reopened could be seamless. According to the European Central Bank, the five largest European countries (France, Germany, Italy, Spain and the UK) used these schemes in a big way. In France and Italy, 40 per cent of employees were in furlough schemes last summer. In Germany and Spain, the share was smaller, though still substantial at 20 per cent; while in the UK, 30 per cent of employees were in furlough schemes at the peak of the crisis.³

Employment data reveals how these schemes affected the labour market. While European employment based on hours worked declined by 15 per cent in the second quarter of 2020 compared to the fourth quarter of 2019, employment based on persons working decreased by only 3 per cent (figure 3). This means employees remained in work but worked substantially fewer hours. There was only a slight uptick in unemployment.

The emergence of excess savings

The second and very welcome effect of the major government policy response has been the stabilisation of disposable income. For the Eurozone and the UK, as a whole, disposable income fell by around 3 per cent in the second quarter – much less than the GDP contraction of more than 13 per cent – and it recovered pretty quickly afterwards.

Of course, there are differences between European economies depending on the depth of the national crisis in terms of both the pandemic and the economy. Italy, Spain and the United Kingdom were heavily affected, while France and Germany saw rapid recoveries in consumption. But nonetheless, as a whole, the European recovery set in quickly.

An important side effect emerges from these trends. Lockdowns coupled with stable income meant that consumers could not spend as they normally would due to limited opportunities – except online. Therefore, the savings rate exploded. It doubled to 25 per cent of disposable income in Q2 2020 compared to Q4 2019 (figure 6). Precautionary motives certainly play a role in this unprecedented increase, but it can be safely assumed that a good part of it reflects involuntary saving.

This assumption is backed by empirical evidence. A survey conducted by the German Central Bank in August after the first lockdown suggests that the two most important reasons for reduced consumer expenditure were that many goods and services were not available and that some spending, such as on commuting to work, was no longer necessary. Reduced income or the fear of reduced income in the future was much less important.⁴

In other words, European consumers are sitting on a mountain of spare cash that they would have spent if they had the opportunity to do so. The amount is impressive. If we make a reasonable assumption of a savings rate of 19 per cent for the whole of 2020, Eurozone consumers would have saved around 450 billion Euros more in 2020 than in 2019 – the equivalent of around 7 per cent of total consumer spending in 2019. On a country level, excess savings per capita compared to 2019 range from 1,300 Euro in Spain to more than 2,000 Pounds in the United Kingdom. These savings could play an important role in the recovery. The use of only parts of them could provide a substantial boost to consumer spending in 2021 and in following years. Therefore, how, when and how fast this money is spent will be crucial factors for the recovery.

The make-or-break factors

It cannot be predicted with certainty how consumers will behave after the immediate health crisis is over and the normal pattern of consumer spending is possible. The crucial factors will be the successful and rapid roll-out of vaccinations and consumers’ financial position and feeling about their finances, which will influence their spending of disposable income.

The economic factors will depend on the ramifications of the crisis – in economics jargon, the so-called scarring. If many people have lost their jobs and companies have gone out of business, household finances and consumer sentiment will be depressed. However, the experience after the first wave of infections and lockdowns provides some hope in this respect. Consumption rebounded very quickly in Q3 2020, indicating that consumers were happy to open their wallets again (figure 7). Scarring after the first wave did not emerge to a noticeable degree, even if some consumption, such as restaurant visits, clearly could not be recovered. In China, which largely succeeded in preventing a second wave of infections, demand – especially for services – picked up quickly after containment measures had been lifted, bringing consumer spending to pre-crisis levels already at the end of last year.

History, too, provides some hopeful signs for the recovery. After the SARS epidemic in Hong Kong the economy rebounded sharply. The economy had dipped markedly in Q2 2003 and recovered strongly in Q3 2003 as tourists and visitors from the Chinese mainland flooded back. Consumer fears evaporated once the virus was under control, and their spending recovered quickly.⁵ Although SARS was much less severe than COVID-19 and did not create a supply shock, its example shows that consumer confidence can rapidly rebound after an epidemic.

There are historians who see a more general pattern. Niall Ferguson, the Milbank Family Senior Fellow at the Hoover Institution at Stanford University, believes COVID-19 could be history by the end of 2021 and forgotten soon after, as pandemics tend to disappear quickly from public awareness.⁶ He argues that the 1957–58 pandemic, known as the Asian flu, is broadly comparable to the COVID-19 crisis and is barely remembered today. Other academics, such as Nouriel Roubini, Professor of Economics and International Business at New York University Stern School of Business, however, fear that the COVID-19 crisis could trigger a storm of financial, political, socioeconomic, and environmental risks, provoking a depression in the current decade.

Scenarios: The very good, the good and the ugly

Limiting the time horizon to the more immediate future, three scenarios for consumer expenditure in the Eurozone are conceivable (figure 10). They hinge on the success and speed of vaccination campaigns as well as on the post-pandemic condition of consumers in Europe.

Baseline: The good – a return to pre-crisis levels of consumption by Q2 2022

Consensus forecasts expect economic uncertainty to linger and COVID-19 restrictions to be extended well into the first quarter of 2021, stalling recovery in the Eurozone. An easing of lockdown restrictions in the spring and summer will support a rebound in consumption, particularly for services. This rebound will be partly offset by rising unemployment as policies supporting the labour market are wound down. Deloitte Research expects that the pre-crisis level of GDP will not be reached until the second quarter of 2022. While consumer sentiment and spending may recover in this scenario, they may do so cautiously and in spurts as people wait to see what happens in the labour market, as well as the economic policy reactions and COVID-19 crisis management. Moreover, the rapid recovery in durable goods suggests that some of the demand in this category was front-loaded and its role as a driver of demand will possibly be muted compared to previous recoveries. However, the more confident consumers become that the crisis is over, the faster consumption may rebound. On the basis of the current parameters, a moderate recovery in consumption seems plausible in the second quarter of 2021, accelerating in the third quarter.

The ugly – a return to pre-crisis levels of consumption by Q2 2023

In the case that vaccines do not prove particularly effective and COVID-19 outbreaks continue to flare, then disruptive stop-and-go lockdowns may remain a feature of society for the future. This would be an extremely negative scenario, especially when coupled with the eventual withdrawal of the expensive furlough subsidies. Any surge in unemployment may deal a severe blow to families’ finances, forcing them to save whenever possible and therefore dampening demand. Economic recovery towards pre-crisis GDP levels would then be a long and arduous process given the harm done to both the labour market and household income. This recovery would look more look like an L or a W than a U or a V.

The very good – a return to pre-crisis levels of consumption by Q4 2021

Some countries have proven that a quick vaccination roll-out is possible. At the time of this writing, nearly one-third of the UK population has been vaccinated. If vaccines begin to be distributed more quickly in other European countries and labour markets continue to come through the crisis relatively unscathed, then governments could end lockdown restrictions earlier than planned and wind back the various job protection schemes without too much disruption. This could encourage consumers to spend the large amount of money saved during the crisis. A release of pent-up demand could lead to a virtuous circle in which increasing demand continues to improve the business climate to the point that corporate investments are again stimulated. A sharp rebound in consumer demand may, however, lead to a temporary spike in inflation. In the most extreme form of this positive scenario, we could experience another Roaring Twenties, a decade of economic growth and prosperity that followed the end of the First World War and the receding of the Spanish flu.

Implications

Which scenario is more likely, and how can retail and consumer goods executives prepare? All three scenarios are plausible, but the baseline scenario seems the most likely at the time of this writing. Given the many uncertainties and risks, the more extreme scenarios should be included in strategic planning. Consumer-facing businesses should thoroughly analyse how dependent their business is on the business cycle. There are huge differences in the position of, for example, groceries, tourism and e-commerce in the current crisis. This exercise should be done also on a country level, as it is likely that the speed and depth of the recovery will differ substantially between European countries. Finally, it can be helpful to look at the more extreme scenarios to generate strategic options. How to cope with a continued recession is the most daunting possibility. More enjoyable is to consider how to meet explosive demand should European consumers unload their excess savings quickly.