Research & Policy Briefs From the World Bank Malaysia Hub No. 46 April 26, 2021 Productivity in the Time of COVID-19: Evidence from East Asia and Pacific Francesca de Nicola, Aaditya Mattoo, Jonathan Timmis, and Trang Thu Tran Firms in the East Asia and Pacific (EAP) region have been hit hard by the COVID-19 pandemic, with dramatic and widespread falls in sales and employment. Firm sales in some EAP countries were 38 to 58 percent lower in April or May 2020, compared to the same month in the previous year. Small and medium-sized enterprises (SMEs) have been particularly affected. The pandemic will have a lasting impact on productivity growth as firm indebtedness and increased uncertainty inhibit investment, and firm closures and unemployment lead to a loss of valuable intangible assets. Support for firms is needed but must be based as far as possible on objective criteria, related not only to past performance or current pain but to the potential for firms, including new firms, to thrive in the future. To avoid unduly prolonging assistance, governments should build exit strategies into the design of support measures and commit to phasing support out by linking it to observable macroeconomic indicators of recovery. How Has the COVID-19 Shock Affected Firms? Despite the easing of mobility restrictions, the crisis has delivered a major demand shock. While many firms have reopened, domestic and Firms have been hit hard by the pandemic, with dramatic and widespread foreign demand remains depressed and uneven, with many firms falls in sales and employment. Firm sales in East Asia and the Pacific (EAP) operating at partial capacity. In Vietnam, firm sales in June 2020 had countries were on average 38 to 58 percent lower in April or May recovered to only -43 percent of the prior year, from -53 percent during 2020, compared to the same month in the previous year. the lockdown in April (Business Pulse Surveys). Depressed demand is The COVID-19 shock started as a sudden stop to local consumption often the most frequently reported concern in recent firm surveys and labor supply due to temporary lockdown measures and disruptions to (Business Pulse Surveys; Dai et al. 2020; Hassan et al. 2020). As the health supply chains. Lockdowns translated into temporary business closure and crisis continues, consumers continue to postpone purchases of countries with more extensive reductions in mobility experienced larger nonessentials, such as tourism and garments, particularly affecting firms falls in firm sales (Business Pulse Surveys). Few firms were able to in those sectors. The longer lower demand persists, the more likely that implement new teleworking arrangements in response to the lockdown. liquidity challenges will translate into widespread insolvencies. Early in the pandemic, Chinese manufacturing firms were mainly affected Sales and employment have fallen partly because some firms have by shortages of labor and raw materials, with knock-on disruption to gone out of business, but other firms have also closed temporarily, laying global supply chains reliant on Chinese inputs (Dai et al. 2020). off workers or operating at reduced capacity. While firm bankruptcies are As containment measures have begun to ease, businesses are often difficult to measure, surveys of Chinese SMEs estimated an exit rate reopening. As of June 2020, 46 percent of Vietnamese firms and 23 of nearly 18 percent of firms between February and May 2020, which percent of Philippines firms had reopened after closing temporarily account for approximately 14 percent of total employment (Dai et al. (Business Pulse Surveys). Most businesses are now open, with 97 percent 2020; Huang et al. 2020). Even if firms continue operating, many firms are of firms open in Vietnam, which has successfully contained the pandemic making permanent and temporary savings to their labor costs, by firing so far (figure 1). workers, granting leave, reducing number of hours worked, or cutting wages (figure 2). Figure 1. Operational Status of Formal Firms in Selected EAP Countries as of May, June, or July 2020 SMEs are particularly affected because they are both more vulnerable to the crisis and less able to adapt than larger firms. In China, production Most firms have reopened after closing temporarily during recovered much more quickly in large firms than in smaller ones (Fitch lockdowns in March and April 2020. 2020). SMEs are typically less able to weather the crisis than larger firms Open Closed because they have more limited access to finance and are 100 3 disproportionately reliant on a few key customers. The monthly sales of 24 19 16 SMEs have fallen by 7 to 24 percentage points more than of larger firms in 80 EAP countries (figure 3). However, demand for essentials remains strong 56 and households across the EAP region are shifting to new areas of Percent of firms spending online, such as groceries and entertainment (Yendamuri, 60 Keswakaroon, and Lim 2020). SMEs are typically less able to take 84 97 advantage of these changes by adopting digital business models, such as 40 76 81 e-commerce. 20 44 What Are the Implications for Firms and Future Productivity? 0 Philippines Indonesia Cambodia Myanmar Vietnam Aggregate productivity is determined by the productivity of firms that go out of business, the productivity of new start-ups, and changes in Source: Business Pulse Surveys. the productivity of continuing firms. The COVID-19 crisis will have a Note: Operational status at the time of the survey reflects formal sector firms and lasting impact on productivity growth through three channels: (1) was conducted in May 2020 for Myanmar; June 2020 for Cambodia, Indonesia, Vietnam; and July 2020 for the Philippines. “Open” includes partially open; hence productive firms going out of business and the loss of irreplaceable the share of open firms might overestimate the extent of operations. “Closed” is intangibles; (2) fewer new innovative start-ups; and (3) diminished likely underestimated due to sample bias. productivity-enhancing investments within continuing firms. Affiliations: Francesca de Nicola, Aaditya Mattoo, and Jonathan Timmis, East Asia and Pacific Chief Economist Office, World Bank; Trang Thu Tran, Finance, Competitiveness & Innovation Global Practice, World Bank. Acknowledgements: The authors thank Yu Cao, Young Eun Kim, and Norman V. Loayza for useful comments and suggestions. Sarah Hebous provided excellent research assistance. Nancy Morrison provided editorial assistance. Objective and disclaimer: Research & Policy Briefs synthesize existing research and data to shed light on a useful and interesting question for policy debate. Research & Policy Briefs carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions are entirely those of the authors. They do not necessarily represent the views of the World Bank Group, its Executive Directors, or the governments they represent. Productivity in the Time of COVID-19: Evidence from East Asia and Pacific Figure 2. Employment Adjustments by Firms in Selected EAP Countries as of June or July 2020 Even if firms continue operating, many are cutting their labor costs. Hired workers Fired workers Granted leave Reduced wages Reduced hours 60 52 50 41 Percent of firms 40 37 29 30 22 20 23 18 15 17 20 14 15 12 8 6 8 10 5 1 0 Cambodia Indonesia Philippines Vietnam Source: Business Pulse Surveys. Note: The share of firms that have hired, laid off, granted leave, reduced wages, or reduced hours for any employees in the last 30 days prior to the survey does not necessarily sum to 100 percent. The survey reflects largely formal sector firms and was conducted in June 2020 for Cambodia, Indonesia, and Vietnam; and July 2020 for the Philippines. Figure 3. Drop in Monthly Sales Reported by Microenterprises, SMEs, and Large Firms in Selected EAP Countries as of May, June, or July 2020 Smaller firms had the largest drop in sales. Micro SME Large 0 Percentage drop in monthly sales -20 versus prior year -29 -40 -37 -37 -44 -42 -49 -60 -52 -51 -53 -51 -58 -56 -58 -60 -59 -80 Cambodia Indonesia Myanmar Philippines Vietnam Source: Business Pulse Surveys. Note: The survey reflects largely formal sector firms and was conducted in May 2020 for Myanmar; June 2020 for Cambodia, Indonesia, and Vietnam; and July 2020 for the Philippines. “Monthly sales” refers to firm sales in the last completed month (in the case of Myanmar) or the last 30 days (Cambodia, Indonesia, Vietnam) prior to the survey, relative to the same period in 2019. In the case of the Philippines, the change is between July and April 2020, when Enhanced Community Quarantine (ECQ) was adopted. “Micro” is defined as firms having fewer than 5 employees; “SME” (small and medium enterprise) as having 5–99 employees; and “large” as having 100+ employees. First, without support, the crisis will lead to the exit of many good and slowing the recovery. Job losses could mean the destruction of bad firms. More productive firms may be better able to weather the firm-specific worker’s skills and know-how. Unemployment could deprive ongoing crisis, through a broader customer base and/or better access to the firm (if it survives) of hard-to-replace skills and reduce the worker’s finance, and/or by adapting new business models. In such cases, the crisis future earnings—if they are unable to use these firm-specific skills may improve aggregate productivity by weeding out poor-performing elsewhere. These so-called intangible assets comprise substantial firms and allowing room for better firms to grow. However, all firms are investments that are an increasingly important part of modern business vulnerable to persistently low demand and inadequate access to credit. models and matter greatly for firm productivity (see, for example, Bloom Evidence from past crises suggests that some strong firms may also be and Van Reenen 2010; Corrado et al. 2018; Haskel and Westlake 2018). weeded out along with the weak firms (Foster, Grim, and Haltiwanger 2016; Hallward-Driemeier and Rijkers 2013). Larger and financially Second, start-ups are likely to be particularly affected. A missing healthier firms appear to be more insulated from the crisis, but larger generation of start-ups may scar longer-term productivity growth. Fewer firms are not always more productive, particularly in services (Bajgar et al. start-ups are entering during the crisis. New business registrations 2019; Ding et al. 2020). dropped 70 percent in Myanmar in April 2020 compared to March 2020, and by 5.1 percent in Vietnam in the first seven months of 2020, The exit of good firms may mean the loss of intangible assets that compared to the same period in 2019 (Myanmar Times 2020; National matter for productivity and that are difficult to rebuild. Disruptions to Business Registration Portal 2020). The crisis may also scar the growth of firms could lead to the permanent loss of important supply chain those start-ups that survive. In many countries, the cohort of new firms relationships or relationships within the firm that are difficult to rebuild, entering during the global financial crisis had persistently lower growth 2 Research & Policy Brief No.46 rates than those entering before the crisis (Calvino, Criscuolo, and Menon In response to the COVID-19 crisis, more than half of EAP countries 2015; Moreira 2017). Start-ups can play a key role in diffusing new have introduced some form of wage subsidy (World Bank 2021). technologies and business models (Criscuolo, Gal, and Menon 2017; Approximately one-quarter of the COVID-19 policies in EAP explicitly Haltiwanger, Jarmin, and Miranda 2013). Therefore, while the absence of target SMEs, for instance through subsidies or new credit lines (World start-ups may not adversely affect aggregate productivity in the short Bank 2021). term because these firms are small, their absence may matter much more for long-term growth. However, support has not reached many firms (figure 5). The share varies substantially by country, ranging from less than 10 percent in the Third, surviving firms may face prolonged uncertainty and be saddled case of Indonesia to around 20 percent in the Philippines and Vietnam. with debt—reducing their future productivity-enhancing investments. Lack of awareness is also a major barrier to firms taking up available These investments often incur sunk costs that only pay off over the longer COVID-19 support (Apedo-Amah et al. 2020). In Indonesia, most surveyed term, including investment in intangibles such as data and artificial firms were unaware of public support. intelligence (AI), worker training, and developing new products. Informal firms and microenterprises are difficult to reach through Uncertainty and financial constraints can deter these investments government policy because they often operate outside formal financial because they are long term and irreversible (Aghion et al. 2010; Barrero and tax systems. For these firms, policy is directed better to support et al. 2017). During past crises, firms were less likely to undertake informal workers, through social protection, rather than support the firms disruptive, radical innovation and disproportionately cut back on per se. Mason et al. (2020) discuss these social protection measures. This intangible investment (Duval, Hong, and Timmer 2020; Granja and Brief focuses on the formal sector. Moreira 2019). The pandemic has led to enormous increases in firm uncertainty, dwarfing those recorded during the global financial crisis How Can Policy Best Strike a Balance between Immediate (Baker et al. 2020; Bloom et al. 2020; Hassan et al. 2020). Firms have responded by significantly cutting expenditures on innovation, training, Relief, Rapid Recovery, and Longer-Term Productivity and general management improvements, which is likely to curb future Growth? productivity growth considerably (Baker et al. 2020). Why Targeted Support May Be Needed in the Short Term One potential bright spot is that the COVID-19 crisis has accelerated Crises are bad selectors, driving out both productive and unproductive investment in digital technologies that may translate into faster firms as slumps in demand are compounded by the increased risk productivity growth. Crises can enable the diffusion of new business aversion and informational inadequacies in capital markets. Therefore, models and digital technologies: for instance, e-commerce in China grew policy support is necessary to help good firms survive. Support is also in the wake of restrictions put in place due to 2003 SARS outbreak. In EAP, socially desirable if the benefits to society from the firms’ survival the COVID-19 pandemic has led to many firms accelerating their use of outweigh the costs—which include the direct costs of raising resources to digital platforms (figure 4). Moreover, the crisis may be catalyzing the use support firms (through taxes or government debt) and the indirect costs of digital financial services, such as through cash transfers or contactless of supporting less productive firms (along with good ones) in the effort to payment systems. Across 74 countries, daily downloads of fintech apps provide broad and immediate relief—thus leaving fewer resources for have increased 24 percent since their COVID-19 lockdown, with a marked productive uses and ultimately slowing recovery. 65 percent increase in Asia (Fu and Mishra 2020). However, increased use of digital technologies may also widen disparities between firms and Implementing support for firms during the COVID-19 crisis entails locations able to adopt new technologies and those that cannot. Insofar trade-offs. In principle, optimal support would balance the benefit of as digital technologies lead both to productivity growth of adopting firms preserving potentially valuable firm-specific assets that would be lost if and a reallocation of activity toward them, this can lead to higher aggregate productivity. Figure 4. Use of Digital Platforms and Investment in Digital Solutions by Formal Firms in Selected EAP Counrtries as of May, June, or July 2020 What Has the Policy Response Been So Far? Many firms have accelerated their use of digital technologies Governments have introduced a wide range of measures to limit firm in response to the pandemic. bankruptcies and employment losses, helping firms directly as well as indirectly via the financial sector. Direct assistance has come in the form Increased or new use of digital platforms of tax relief, wage or rent subsidies, and soft loans or credit guarantees. Increased digital sales Indirect assistance has involved injecting liquidity into the banking system New digital investment 60 or relaxing banking sector regulations. Some policies, such as government 53 52 debt financing or issuing credit guarantees, fall in between. The initial 48 50 response has in part relied on existing schemes, as exemplified by the expansion of financing program for micro, small and medium enterprises 40 Percent of firms 40 36 by the Small Business Corporation in the Philippines. The repurposing of 28 30 existing policy interventions can be easier and quicker to scale up. 30 23 In contrast, business climate reform, which is likely to matter for the 20 19 20 17 recovery, represents less than 10 percent of all post-COVID-19 policy 14 actions in EAP countries (World Bank 2021, as of August 31, 2020). As the 10 5 next section will discuss, reducing red tape presents an opportunity to encourage the entry and growth of new innovative firms. 0 Evidence from past crises suggests that wage subsidies and Indonesia Philippines Vietnam Cambodia Myanmar additional capital can help smaller firms survive and recover. Wage subsidies in Mexico after the global financial crisis speeded up Source: Business Pulse Surveys. Note: Data on increased digital sales and new digital investment is not available employment recovery, especially for smaller firms (Bruhn 2020). Cash for Myanmar. The share of firms that increased digital sales is estimated for those grants in Sri Lanka after the 2004 tsunami helped microenterprises reporting positive digital sales only. The survey reflects formal sector firms and was conducted in May 2020 for Myanmar; June 2020 for Cambodia, Indonesia, survive the crisis and speeded their recovery (De Mel, McKenzie, and and Vietnam; and July 2020 for the Philippines. Woodruff 2013). 3 Productivity in the Time of COVID-19: Evidence from East Asia and Pacific the firm exits against the drag of supporting less productive firms. In Figure 5. Formal Firms Receiving Policy Support in Selected EAP practice, government support faces one key trade-off: immediate Counrtries as of June or July 2020 but indiscriminate implementation versus slower but targeted implementation. Firms highly reliant on cash flows may not long survive a shock of the magnitude and depth generated by the pandemic. Prompt A small fraction of firms have received policy support. government action is needed to avoid igniting downward spirals. But prompt action is likely to be indiscriminate, at least initially, because Has access to policy support designing new, targeted policies takes time. The downside is that broad No access: Not aware of policies support may keep zombie and less productive firms afloat along with No access: Application too difficult more productive firms. When more capital is sunk in zombie firms, the No access: Not eligible resources available for more productive firms to scale up are more limited No access: Applied but not received (Andrews, McGowan, and Millot 2017). As the COVID-19 pandemic persists, broad support may become less Indonesia desirable. While indiscriminate support aimed at keeping many firms afloat can be desirable in the immediate arrival of the crisis, it may be impractical and inefficient to do so for a longer duration. First, reaching a broad number of firms is typically more costly than targeted implementation, and such costs mount the longer the crisis persists. Vietnam Second, the longer zombie and less productive firms are preserved, the greater the drag on reallocating resources to more productive uses, impeding recovery. Therefore, policy should strive for a more efficient allocation of Philippines financial support today. Support is rarely indiscriminate. Even when it is in principle available for all firms, only some firms may be adequately 0 20 40 60 80 100 informed, identified, or politically connected to take advantage of it. In Percent of firms EAP countries, a minority of firms have had access to COVID-19 support, with most either unaware or finding the application too difficult (figure 5). The characteristics of these firms that take advantage of policy are often Source: Business Pulse Surveys. Note: The survey reflects formal sector firms and was conducted in June 2020 for opaque. Therefore, the challenge is to define objective and transparent Indonesia and Vietnam; and July 2020 for the Philippines. criteria, to both avoid supporting unproductive firms and mitigate concerns about picking winners. Ideally, support criteria would be based not only on past performance microenterprises and informal firms, which account for most firms in EAP or current pain but on a firm possessing assets that will be valuable in the countries and are difficult to reach through the financial and tax systems. future but would be completely lost if the firm exits. Many intangible Instead, support can target productive activities, rather than assets are firm specific and irretrievable, unlike tangible assets such as productive firms per se. For example, policy can be directly tailored to land or machinery that could be repurposed in other firms. Intangibles, encourage new investment in intangibles and promote long-term such as firm-to-firm and firm-to-worker relationships, have been productivity growth. The recovery depends both on the preservation of becoming much more important to productive firms’ business models. existing high-potential firms with intangible assets and future Therefore, preserving these assets is likely to be important for the investment in new intangibles. For example, policy can specifically recovery. encourage investments in R&D or encourage skills training through tax incentives. Challenges of Implementing Targeted Support There are trade-offs in the choice of institutions to implement Even if targeted policy support is necessary and desirable, it is difficult to targeted support—either directly via the government or indirectly design, implement, and credibly phase out. through financial institutions. On the one hand, banks are likely to have Identifying high-potential firms is not straightforward. For instance, access to additional sources of information about their client firms that support criteria may target firms with irreversible intangible assets. are not available to the government, which may allow for better However, measuring intangible assets is often difficult. Data may be targeting. On the other hand, banks’ incentives to lend (to less-risky, available for some innovation investments like Research & Development larger, and older clients) may differ somewhat from the government’s (R&D), but data are much scarcer on investments in branding, desire to support productive firms (that may include more risky firms firm-specific management skills, or information technology (IT). In some with more radical business models or start-ups). cases, past performance, as revealed by previous years’ profits, tax Governments must credibly commit upfront to terminating revenues, or trade flows, or current performance, as reflected in stock assistance when it is no longer needed to avoid the risk of capture by prices, may also provide clues on firm potential. For example, controlling politically connected firms. This concern is relevant, however the policy for market risk, there is as much as a 25 percent gap in cumulative return support is designed and implemented. Policies once enacted are often between more and less resilient firms in US asset markets (Pagano, difficult to retract and beneficiaries have an incentive to lobby for Wagner, and Zechner 2020). continued support. For example, in Brazil, credit market interventions in Rather than targeting firms directly, the choice of policy instruments response to the global financial crisis continued to expand even after the can lead to the self-selection of firms with desirable characteristics. Social economy recovered (Bonomo, Brito and Martins 2015). To avoid this risk, security deferrals in China, for example, have been found to exit strategies should be designed and committed to at the point of disproportionally benefit firms with a high share of skilled workers who inception. One option is to link legally the continuation of support to are likely to be associated with firm-specific mutual investments (Chen et certain objective macroeconomic indicators of recovery, such as the al. 2020). In contrast, workers in firms with few specific assets are unemployment rate or industrial production, or other high-frequency 4 better supported through social protection measures. This includes indicators that are already collected. Research & Policy Brief No.46 The Importance of Policy Reform for Longer-term Growth • Transparent policy implementation and simplification of procedures to access support can help increase policy awareness and allow policy to While firm support can provide immediate relief, broad policy reforms to reach a broader set of firms. improve the business environment are crucial for longer-term growth. Business environment reforms are typically triggered by a crisis because Broad policy reforms to the business environment, while they can they are much harder to implement in normal times. Thus, the COVID-19 take time, support the entry and expansion of innovative businesses—the crisis represents an opportunity to get the policies right for broad-based productive firms of tomorrow. Broad reforms have the advantage that recovery and productivity growth. they allow firms to self-select into the policies, and avoid the difficulties of designing policy for a targeted group of firms. Although the support of Conclusion existing productive firms today is important, the recovery also depends The COVID-19 pandemic has hit firms hard, with many firms facing upon new innovative firms—and the entry and growth of start-ups is prolonged exposure to low levels of demand and increased uncertainty. particularly sensitive to the business environment (Calvino, Criscuolo, and The longer the crisis persists, the greater the potential risk to recovery Menon 2016). Broad reforms helpful to long-term growth include the and inclusive growth. Record levels of uncertainty have led many firms to following: postpone investments. SMEs appear to be particularly hard hit and are less able to adapt by going digital. Firm closures and unemployment will • Strengthening venture capital and early-stage finance market lead to a loss of valuable firm-specific intangible assets. development, through tax policy, public funding, or regulatory reform can all help innovative start-ups. EAP countries have responded rapidly with wide-ranging support to • Reducing red tape and streamlining regulatory systems can facilitate firms. As the COVID-19 crisis persists, broad support may be less firm entry and reduce the bureaucratic advantages of incumbents. desirable. However, targeted support must be based as far as possible on • Improving insolvency resolution can promote the exit of zombie firms, objective criteria related to the potential to thrive in the future. Lessons freeing resources for productive firms to scale up (Andrews et al. from past crises highlight the difficulties of phasing out support packages. 2017). The introduction of specialized bankruptcy courts in selected To avoid this risk, governments can commit to phasing support out by Chinese cities has led to faster resolutions of bankruptcy cases, linking it to observable macroeconomic indicators of recovery. decreased the share of labor in zombie-intensive industries, and However, support to firms should be viewed as an integrated part of increased the average product of capital (Li and Ponticelli 2020). broader policies. Business environment reforms started today can help • Accelerating infrastructure investments, such as improving access to support the entry and expansion of the productive firms of tomorrow. digital infrastructure, can reduce the barriers to broader adoption of Building capacity for rapid COVID-19 testing and tracing will limit the need digital business models, such as e-commerce and remote working. for costly firm lockdowns in the future. 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