Although global economic activity is recovering and output in Europe and Central Asia (ECA) is expected to grow in 2021, containing COVID-19 remains a challenge in the region. Enterprise survey data for the emerging and developing countries in the region show that COVID-19 had a profound and heterogeneous impact on firms. Smaller, younger, and female-run businesses were hit harder and had greater difficulty recovering. But the crisis also played a cleansing role and economic activity in ECA appears to have been reallocated toward more productive firms during the crisis, particularly in countries with more competitive markets. Firms with high pre-crisis labor productivity experienced significantly smaller drops in sales and employment than firms with low pre-crisis labor productivity and were also more likely to adapt to the crisis by increasing online activity and remote work. Many governments in ECA implemented broad policy support schemes to address the initial economic fallout from the crisis. Overall, this government support was more likely to go to less productive and larger firms, regardless of the level of their pre-crisis innovation. As economies enter the economic recovery phase, it will be important for policy makers in all countries to phase out broad policy support measures as soon as appropriate and focus on fostering a competitive business environment, which is key to a strong recovery, resilience to future crises, and sustainable, long-term economic growth.

Although global economic activity is recovering and output in Europe and Central Asia (ECA) is expected to grow in 2021, containing COVID-19 remains a challenge in the region. Enterprise survey data for the emerging and developing countries in the region show that COVID-19 had a profound and heterogeneous impact on firms. Smaller, younger, and female-run businesses were hit harder and had greater difficulty recovering. But the crisis also played a cleansing role and economic activity in ECA appears to have been reallocated toward more productive firms during the crisis, particularly in countries with more competitive markets. Firms with high pre-crisis labor productivity experienced significantly smaller drops in sales and employment than firms with low pre-crisis labor productivity and were also more likely to adapt to the crisis by increasing online activity and remote work. Many governments in ECA implemented broad policy support schemes to address the initial economic fallout from the crisis. Overall, this government support was more likely to go to less productive and larger firms, regardless of the level of their pre-crisis innovation. As economies enter the economic recovery phase, it will be important for policy makers in all countries to phase out broad policy support measures as soon as appropriate and focus on fostering a competitive business environment, which is key to a strong recovery, resilience to future crises, and sustainable, long-term economic growth.

Governments play a critical role in the economies of Europe and Central Asia, where government expenditures are close to 40 percent of gross domestic product and the public sector accounts for nearly 27 percent of total employment, which is almost twice the global average. The public sector often attracts some of the best educated workers in the region. And support for a larger public sector is increasing due to aging populations and their growing health care and long-term care needs, rising inequality and greater support for redistribution, and increasing expenditures as governments address the challenges posed by the COVID-19 crisis. The significant role that government plays underscores the importance of the quality of governance in determining productivity and growth and effectively responding to the region’s economic and social challenges. Digital technology and the data revolution offer the potential to increase efficiency, transparency, responsiveness, and citizen trust, directly impacting the quality of government. Across the world, the quality of government is increasingly informed by the extent to which governments harness digital tools and GovTech to optimize management, service delivery, and overall state capacity. Technology and data are also key for fostering collaboration between governments and civil society to improve public sector efficiency and service delivery. The COVID-19 pandemic has highlighted the costs associated with delaying digitalization and GovTech implementation and the opportunities that lie in public sector modernization.

Economic growth slowed sharply last year in Europe and Central Asia, as Russia's invasion of Ukraine, a surge in inflation, and the sharp tightening of monetary policy and financing conditions hit private consumption, investment, and trade. The marked increase in food and energy prices boosted inflation to a pace not seen in 20 years. The burden of inflation was spread unevenly across households. The poorest households faced inflation that was more than 2 percentage points higher than the inflation faced by the richest households, with this difference exceeding 5 percentage points in some countries. Poverty and inequality rates derived from household-specific inflation rates differ from those based on the standard consumer price index (CPI) approach. These differences have important policy implications, because many programs use CPI†“based inflation adjustments, which do not accurately capture changes in the cost of living of targeted populations. Output growth in the region is projected to remain little changed in 2023 but better than projected in January 2023, largely reflecting upgrades to the pace of expansion in Poland, Russia, and Türkiye.

In February 2022, the world was shocked by the Russian Federation’s invasion of Ukraine. The war is having a devastating impact on human life and causing economic destruction in both countries, and will lead to significant economic losses in the Europe and Central Asia (ECA) region and the rest of the world. It comes at a particularly vulnerable time for ECA as its economic recovery was expected to be held back by scarring from the pandemic and lingering structural weaknesses. The economic impact of the conflict has reverberated through multiple channels, including commodity and financial markets, trade and migration links, and the damaging impact on confidence. Moreover, the war has added to mounting concerns about a sharp global slowdown, surging inflation and debt, and a spike in poverty levels. Neighboring ECA countries are likely to suffer considerable economic damage because of their strong trade, financial, and migration links with Russia and Ukraine. The war is also causing a destabilizing wave of refugees, financial stresses in vulnerable countries, runaway inflation expectations, and food insecurity. A protracted conflict could further heighten policy uncertainty and fragment critical trade and investment networks.

Governments play a critical role in the economies of Europe and Central Asia, where government expenditures are close to 40 percent of gross domestic product and the public sector accounts for nearly 27 percent of total employment, which is almost twice the global average. The public sector often attracts some of the best educated workers in the region. And support for a larger public sector is increasing due to aging populations and their growing health care and long-term care needs, rising inequality and greater support for redistribution, and increasing expenditures as governments address the challenges posed by the COVID-19 crisis. The significant role that government plays underscores the importance of the quality of governance in determining productivity and growth and effectively responding to the region's economic and social challenges. Digital technology and the data revolution offer the potential to increase efficiency, transparency, responsiveness, and citizen trust, directly impacting the quality of government. Across the world, the quality of government is increasingly informed by the extent to which governments harness digital tools and GovTech to optimize management, service delivery, and overall state capacity. Technology and data are also key for fostering collaboration between governments and civil society to improve public sector efficiency and service delivery. The COVID-19 pandemic has highlighted the costs associated with delaying digitalization and GovTech implementation and the opportunities that lie in public sector modernization.

Globalization, demographic trends, the green transition, and technological innovations are transforming labor markets in Europe and Central Asia, altering their institutional and contractual arrangements, and creating disparities and vulnerabilities in the labor force. Systemic risks—economic, health, or climate-related—are also playing an increased role in driving poverty and vulnerability. Social protection systems in Europe and Central Asia will need to be reformed to address these challenges and provide adequate protection to workers and families. Countries in the region responded to the COVID-19 pandemic by implementing social protection packages with a substantial contribution of job protection policies. Analysis of the impact of these policies suggests that while job protection policies may have preserved employment in the short run, this may have come at the expense of efficiency and growth. In the long run, income protection policies may be better at addressing the needs of vulnerable groups as labor markets continue evolving. A policy package that combines a guaranteed minimum income with labor market policies that facilitate job transitions can best help countries address long-term challenges.