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US, Europe could face a '98% economy' in years ahead – BIS

Advanced economies such as the U.S. and Europe may face a "98% economy" in the coming years as the uneven impact of the coronavirus pandemic across sectors leads to a lower level of potential output, according to a report from the Bank for International Settlements, or BIS.

The BIS said model projections indicate that large advanced economies could face a "98% economy," meaning that their GDP could only recover to 2% below its pre-pandemic trend at best, until regulatory and behavioral constraints on customer service industries are eased.

"One view is that depressed conditions in customer service industries, which account for around 10% of GDP in many economies, will gouge a persistent hole in economic activity, leaving countries with a '90% economy,'" BIS senior economist Daniel Rees wrote in the report.

The impact of the coronavirus pandemic has been uneven across sectors, with the output of customer service industries expected to remain below the pre-pandemic trend for some time, indicating a slower growth expectation for economies with large customer service industries in the near term, the report said.

The outlook for China and Australia is more positive, according to the report. China's economy is less oriented toward customer service industries, while Australia is expected to face a smaller decline in customer service output, the BIS noted. On the other hand, Thailand is projected to face a "95% economy" because it is heavily reliant on its large tourism industry.

The BIS report said demand stimulus would not be sufficient to push economic activity back to its pre-pandemic level. The reported cited the need for public health measures to contain the pandemic and ease resource allocation to industries less affected by the pandemic.

"Market economists expect the effects of containment measures and outbreak severity to be temporary — these variables do not affect forecasts of the level of GDP at the end of 2021," Rees said. "However, the contractionary effect of exposure to customer service industries is expected to persist," he added.

Rees said economies become less efficient due to the supply disturbances in customer service industries, leading to declines in total output volumes and, in turn, lower wages and profit incomes.

"In reality, a combination of industry-level supply- and demand-side disturbances, as well as economywide aggregate disturbances, is necessary to explain declines in output that occurred in the first half of 2020," Rees said.