Is digital economy the way out of the current crisis?

The digital economy has been a key contributor to the economic development of countries in central and southeastern Europe. As Europe tackles the combined crises triggered by the pandemic and the invasion of Ukraine, digital economy may emerge as the means to mitigate the impacts.

The digital economy has historically been a key growth driver for the ten countries that are known as Digital Challengers—Bulgaria, Croatia, the Czech Republic, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia, and Slovenia. This trend continued in the past five years, the digital economy of the Digital Challengers cluster growing by 51% in 2017–21. The pace of this growth was higher than the annual GDP growth in the region, which was 4% in 2017–19 and 3 percent in 2019–21.
Digital commerce shot ahead by two to five years during the COVID 19 pandemic and is expected to continue as a growth engine. Digital commerce in the Digital Challengers cluster grew by more than EUR 21 billion in 2019–21, accounting for more than 80% of growth in the digital economy in the period, according to a study published by McKinsey. This led to an acceleration of the development of online channels by two to five years.

Impact of current crisis on digital economy
As Europe emerges from the COVID 19 crisis, the geopolitical instability related to the invasion of Ukraine and rising prices have become the top areas of concern for Europeans. Annual inflation in several of the Digital Challenger countries reached double digits at the end of first half of 2022. The Russian invasion of Ukraine has caused the greatest humanitarian crisis in Europe since World War II. To date, thousands of lives have been lost and millions of people displaced. Some short-term implications for the digital foundations of the CEE region are already clear, however. Rising prices for food and energy, in particular, are impacting the region’s macroeconomic performance, with inflation in April 2022 reaching over 10% annually in most Digital Challenger countries.
Increasing economic volatility, growing uncertainty, and disrupted supply chains are decreasing disposable income and consumer sentiment. The invasion of Ukraine has also brought concerns about cybersecurity. In response, companies and governments have focused on evaluating their exposure to cyberattacks and making the necessary adjustments to their digital infrastructure to ensure cybersecurity.
The current environment could potentially impact all components of the digital economy. Digital commerce may see the strongest negative impact, as consumption by local populations is depressed by increased uncertainty, worsening consumer sentiment, and soaring prices—especially for essentials. Among the poorest European households, discretionary spend already shrank by over 10 percent between February and the end of April 2022. Companies from CEE countries may further be impacted by declining exports to Ukraine and their withdrawal from operations in Russia. At the same time, the demographic base of CEE countries is changing, with most of the refugees being women, children or the elderly. Based on border crossing data, the number of refugees that have entered CEE countries are up to 3.1 million in Poland, 0.8 million in Romania, 0.6 million in Hungary, 0.4 million in Slovakia, and 0.3 million in the Czech Republic.
The ICT sector is high on the agenda of governments and businesses due to concerns about cybersecurity. Attacks on critical infrastructure can cause disturbance in multiple sectors—an attack on the telecommunications infrastructure may disrupt electronic payments, for instance. Individuals and businesses are also increasingly dependent on digital devices. Increased spending on cybersecurity is therefore necessary in order to ensure a thriving economy. Many EU governments are also reshaping their spending priorities. Fifteen NATO countries, plus Sweden, have announced increased defense spending to date, partly dedicated to connectivity and digital devices. Increased defense spending may come, albeit to a limited degree, at the expense of government investment in local telecommunications infrastructure. Supply chain disruption can also have an impact on the availability of finished goods within the IT sector. However, this impact is likely to be moderate compared to the impact on other sectors, as electrical equipment, appliances, and machinery have lower export dependency on Ukraine and Russia, these two countries being the exporter of around just 0.5 percent of total global exports.

Digital economy in the new reality
Digital technology, processes, and infrastructure allow countries to respond rapidly to changing economic conditions and provide support during a recovery, the McKinsey report argues. For instance, Ireland stands out as recording positive real GDP growth in 2019–20, at 5.9%. The country saw an increase in exports during the initial stages of the pandemic due to the strong presence of multinational companies from the pharmaceutical and digital sectors in the country, such as Google and LinkedIn, both headquartered in Dublin.
The current macroeconomic conditions and the inflationary pressure emphasize the need for resilience. The digital economy is a proven driver of mitigating inflation in these circumstances: a paper by Goolsbee and Klenow54 highlighted that online inflation was 1.3 percentage points lower than the CPI in 2014–2017 in the United States. The Economist55 also argued in 2019 that “the internet in general is no place to go in search of inflation: in America online prices have been falling fairly steadily since about 2012 and are lower than they were at the turn of the millennium”. This suggests that digital commerce is more resilient toward inflationary pressure than the overall economy and that increasing digital exposure can mitigate the impact of the current crisis, the McKinsey report notes.