/Europe Locked Its Economy in Place. Unlocking It Could Be Ugly.

Europe Locked Its Economy in Place. Unlocking It Could Be Ugly.

For nearly a year, large swaths of Europe’s economy have been in a deep freeze.

In pursuing such policies, European leaders have bet that, once the pandemic subsides, they can defrost the region’s $18 trillion economy, allowing businesses to fire up quickly and bring back workers. It’s an intentional effort to slow an economic deep clean, dubbed by many economists creative destruction. This reflects a political choice: Europeans are generally less tolerant of the brutal adjustments required by the U.S. model of capitalism.

But as the pandemic drags on and Europe’s vaccine rollout is expected to stretch through the year and beyond, some policy makers, economists and business executives worry that mothballing the economy for so long will leave it struggling to adapt to the seismic business and social changes the crisis is driving. That could stall an economic recovery.

“Trying to freeze work where it was and how it was is in many cases a profound mistake, because it delays the corporate reorganizations, new investments and new hires that are necessary,” said

Carlo Bonomi,

chairman of Confindustria, the Italian employers’ federation. While Europe keeps the economy in suspended animation, the U.S. is already creating new jobs and businesses.

The contrasting policy responses feed a question likely to be debated for years: Which economic model better withstands the maelstrom unleashed by the pandemic?

The U.S. approach “is more brutal but also more flexible,” said

Nicholas Bloom,

an economist at Stanford University.

Like Europe, the U.S. has provided vast government support in the pandemic, through payments to businesses and workers and credit from the central bank to support struggling enterprises. The Federal Reserve established facilities to buy high-grade corporate debt, support lending to smaller businesses and enable the issuance of securities backed by small-business, student and-credit card loans, among others. These unprecedented programs helped to preserve jobs and keep alive distressed but solvent companies.

But while governments on both sides of the Atlantic strove to put a floor under the slump, the U.S. did less to stop workers and capital from shifting toward new uses.

Europe’s labor markets were less flexible than that of the U.S. before the pandemic. Europe’s governments have adopted broad social safety nets and job-protection laws, and its muscular trade unions generally won’t tolerate large-scale layoffs. Those attitudes have hardened during the pandemic, a special kind of shock that, unlike most recessions, isn’t the result of excesses or distortions in financial markets or the economy that need to be unwound.

The eurozone economy shrank more than twice as much as the U.S. last year and will recover more slowly this year, according to the International Monetary Fund, largely because European governments adopted draconian social restrictions to contain the virus. The U.S. jobless rate has boomeranged, first cratering close to 15% and then improving sharply, while the eurozone’s headline unemployment has barely budged during the crisis.

Europe registered far fewer business bankruptcies last year than in any of the previous five, while 2020 bankruptcies in the U.S. remained within the pre-pandemic range, according to data from the Bank for International Settlements. Applications to start new businesses in the U.S. rose 42% in the six months through September from a year earlier, but declined slightly in France and Germany, according to Oxford Economics.

Destruction and Creation

Europe has focused on preserving jobs and businesses during the pandemic, while the U.S. has allowed more to be destroyed and new ones to be created.

Number of business bankruptcies in 2020, compared with 2015–2019

Number of business registrations 2020, change from a year earlier

Number of business bankruptcies in 2020, compared with 2015–2019

Number of business registrations 2020, change from a year earlier

Number of business bankruptcies in 2020, compared with 2015–2019

Number of business registrations 2020, change from a year earlier

Number of business bankruptcies in 2020, compared with 2015–2019

Number of business registrations 2020, change from a year earlier

Worker productivity also has risen in the U.S. during the pandemic, but has been flat or down in Germany, France, Italy and Spain, according to

Deutsche Bank.

The U.S. had already outpaced Europe in productivity growth since the 1990s, largely because European businesses were slower to adopt new information technologies. Eliminating unviable jobs and businesses generally is responsible for about half of long-run productivity growth, some economists say.

Meanwhile, the pandemic is accelerating a shift toward new digital business models and automation of processes. Some habits may stick, such as working and shopping from home, permanently reducing the demand for certain services in sectors such as retail or travel. If the shape of the economy looks very different in a couple of years, anything that delays the adjustment to that shock is going to be costly.

Europe’s enthusiasm for job-furlough programs is partly based on Germany’s experience during the 2008-09 global financial crisis, when its program helped to hold down unemployment and quickly restart the economy once demand recovered.

This time, the support to workers and businesses is vastly larger, as governments sweetened or made it easier to access the programs. Almost eight million workers were in job-retention schemes in Germany, France, Italy and Spain in November, or roughly 7% of all workers in those countries, according to the European Central Bank. That was down from about 24 million in April, but still a larger share of Europe’s workforce than at the worst of the financial crisis in 2009.

Furloughed employees typically work reduced hours, or in some cases none, while receiving a portion of their salary. In Germany, such workers cannot undergo training unless it is designated by the labor office, or even be required to look at work emails. In Italy, they usually may not take part-time jobs because they might be called back to work from one day to the next.

At Germany’s Recaro Aircraft Seating GmbH, which makes seats for European, U.S. and Chinese airlines, sales fell 60% last year to about €300 million ($360 million). Chief Executive

Mark Hiller

doesn’t expect sales to return to pre-crisis levels for five years. Some executives and airlines predict business travel won’t ever return to previous volumes.

The warehouse area of a Recaro factory in Qingdao, China, in 2018.



Photo:

Qilai Shen/Bloomberg News

Recaro cut about 30% of jobs at its factories in the U.S. and China last year, but in Germany it hasn’t reduced its workforce of roughly 1,100. Instead, it has tapped the government program, which pays its workers up to 87% of their salary, to a maximum of almost €5,000 a month, to stay home. Almost the whole of Recaro’s workforce is on furlough, working on average 40% fewer hours than normal.

Recaro has agreed not to lay off employees until at least mid-2023. The high cost and legal complexities of doing so in Europe deter many companies from cutting staff.

But job-retention schemes “can only bridge the gap until we’re back on a higher level,” Mr. Hiller said. “If we need to adapt to €300 million [sales] forever, it won’t work.”

Most of his competitors, including in the U.S., are cutting deeper. U.S. defense group Raytheon Technologies Corp. cut a fifth of the workforce in its commercial aerospace division after sales at a unit that competes with Recaro fell 26% last year. Raytheon doesn’t plan to hire all of the people back and will instead automate functions.

The hospitality sector has taken a big share of the furlough programs this time, a change from the 2008-09 recession, when they were tapped heavily by manufacturing companies.

The case for protecting jobs is weaker in less knowledge-intensive sectors such as hospitality, some economists say. Young people might be using these jobs as a steppingstone, so there could be less value in preserving the specific skills and relationships workers have built up, said

Dan Andrews,

a former Australian Treasury official now at the Organization for Economic Cooperation and Development. He said some low-skilled jobs might eventually disappear for good, such as those serving business travelers, as the pandemic accelerates digitization.

A barred shop window in the central Vittorio Emanuele II Gallery in Milan, in November.



Photo:

daniel dal zennaro/EPA/Shutterstock

Before Covid-19 struck,

Orlando Gomes’s

business was setting up tents in Portugal at about 30 events every weekend, from international fairs to weddings. Now his company, Multitendas, is lucky if it gets one event a weekend. Most of his roughly 150 employees have been on furlough for 10 months, paid most of their salaries by the government to stay home.

Mr. Gomes is waiting, hoping for business conditions to improve. He recently received a state-backed credit line for €1.5 million. Switching into new sectors seems impossible, he said, because his work is highly specialized.

“I had planned to decide by year-end whether to shut down or stay in business, but with a vaccine on the horizon, I figure I’ll wait a couple of extra months,” Mr. Gomes said. Some of his workers have left for other sectors such as construction, but most are staying put.

Half of German companies have halted or delayed transformation and innovation projects as a result of furlough programs, according to a survey by Boston Consulting Group.

Job-retention schemes are “a little bit too easy. You can delay decisions and remain in your comfort zone as a manager,” said

Karl Haeusgen,

president of the German Mechanical Engineering Industry Association, a lobby group for a sector that employs around 1.3 million people.

Economists and business executives also say business subsidies could increase the share of “zombie” companies that struggle to earn enough over time to cover their debt-servicing costs, and that can undercut prices charged by healthier competitors. In Germany, the share of zombie companies could increase to 20% of all businesses this year from 7% before the pandemic, according to research by Creditreform, a German credit agency.

Alexander Alban,

managing partner at German mechanical parts manufacturer Walter Schimmel GmbH, hustled last year to keep his business in the black—cutting staff, putting workers on furlough and canceling plans for a new factory—as he coped with a 25% decline in sales.

Though demand fell, a third of that revenue drop was due to a roughly 12% fall in market prices, Mr. Alban said, as struggling local competitors using government support offered low prices to stay afloat.

“These zombie companies…run their business for a couple of months below costs,” Mr. Alban said. “They ruin the market. Afterwards, it’s very hard to get this business back. Usually it’s good if the market is cleaned.”

At the Italian employers’ organization Confindustria, an official said trying to freeze work as it was could be a mistake because it delays necessary corporate reorganizations and new hires.



Photo:

Guglielmo Mangiapane/REUTERS

In Italy, widespread use of job-retention schemes hurt labor productivity growth during the 2008-09 financial crisis, according to a 2018 paper by

Giulia Giupponi

of Bocconi University in Milan and

Camille Landais,

a professor at the London School of Economics. The least productive firms were three times more likely to tap the job-retention scheme than their stronger peers, the researchers found.

In Italy, through early December, 29% of all workers had been placed on furlough since the start of the pandemic, a total of about 6.7 million people.

The furloughs, the ban on layoffs and generous credit helped save about 400,000 jobs during the pandemic, according to an independent report by Bank of Italy researcher

Eliana Viviano.

Antonio Gullo,

who lives in Turin, the heart of Italy’s shrinking auto industry, has been in and out of furlough since 2001. He now works for

Lear Corp.,

a Michigan-based maker of seats and electronics for the car industry. His last full month of work was in 2015, and in two decades he has never had more than 18 months in a row of full-time work, he said. He is currently working about six days a month.

“We live in a state of constant uncertainty; it’s impossible to plan out your life,” said Mr. Gullo, 43, who is on a production line making seats for Maseratis. “Leaving the factory isn’t an option because there aren’t any full-time jobs out there.”

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With so many on furlough, German business groups have warned recently of a shortage of skilled workers in a nation where the unemployment rate is just 4.5%, particularly in energy, mechanical and civil engineering and health.

Germany’s sweetened job-furlough scheme has “crazy consequences,” said

Friedrich Merz,

a senior politician in Chancellor

Angela Merkel’s

Christian Democratic party. “Employees are kept in businesses even though they are needed in other places.”

Still, some businesses say the European model is better in the long run.

The U.S. model weakens the bond between a company and its employees, reducing the incentive for businesses to invest in training, said

Gerd Ohl,

general manager of Limtronik GmbH, an electronics manufacturer based near Frankfurt. He said he had trained American employees in Germany to work for his U.S. subsidiary, only to see them leave the company soon after they returned to the U.S.

Workers at Heidelberger Druckmaschinen’s factory.



Photo:

HEIDELBERGER

At

Heidelberger Druckmaschinen AG

, a maker of printing presses in southern Germany, revenue has fallen about 20% and is unlikely to return to its pre-crisis level for about five years, said

Marcus A. Wassenberg,

chief financial officer. He said around half of the company’s staff are on furlough, down from 80% early in the pandemic, and the company claimed about €85 million via the job-retention program last year.

Mr. Wassenberg said the furlough program was part of a broad net of social protections that helps stabilize Germany’s economy and share the fruits of growth between managers and workers, making its society better able to absorb global shocks.

Write to Tom Fairless at tom.fairless@wsj.com and Eric Sylvers at eric.sylvers@wsj.com

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