The COVID-19 pandemic represents a formidable challenge. Poverty, both moderate and extreme, as well as inequality are increasing worldwide. Only in Latin America, ECLAC estimates that the decline in GDP and the expected rise of unemployment will increase the number of people living in poverty by 45 million. The current crisis jeopardizes the progress made on the SDGs in the last decade; thus, from a developmental point of view, it is key to understand how the pandemic is affecting the economy in the short and medium run.
In this note I focus on the effects of COVID-19 on firms, which are essential in creating value-added in the economy and the ultimate drivers of growth. In particular, I will discuss the effects of the pandemic on firms’ productivity and on the different policy options governments can implement to foster a sustainable recovery. Understanding such impacts and the policies needed to mitigate the destruction of firms and jobs are vital to rebuild the economy and get back on track to achieve the SDGs in the region.
What is Total Factor Productivity?
Total factor productivity (TFP) is a concept used by economists to measure a firm’s efficiency to combine production factors, such as physical capital, human resources, and intermediate materials when producing a final output unit. We say that a worker in Europe is more productive than one in Latin America if, with the same level of inputs, the European employee produces more goods or services. This situation may be due to factors such as the better organization of work, the use of more technologically advanced capital, more significant workers’ efforts, or the existence of a regulatory framework that recompenses the most efficient companies.
Various studies indicate that productivity differences explain close to 70% of the differences in per capita income and between countries (Hsieh and Klenow 2010). TFP is also considered a main explanatory factor for nations’ economic growth rates (Kim and Loayza 2019). In Latin America, studies by the IDB indicate that TFP is the predominant factor explaining the region’s low income as it relates to advanced economies (IDB 2010). In the words of Paul Krugman, “Productivity is not everything, but in the long run, it is almost everything.”
Increased productivity is a critical factor for sustainable economic growth and development, generating quality jobs and eradicating poverty. The pandemic caused by COVID-19 has short and medium-term effects that need to be understood to design adequate public policies to avoid permanent drops in productivity, support the recovery, and underpin a new cycle of economic growth.
COVID-19 and Productivity in the Short-Term
In the short term, the COVID-19 pandemic is having a drastic impact on economic activity that, in turn, generates significant drops in productivity. According to the World Bank Group (WBG), the world is experiencing its worst recession since the Great Depression of the 1930s. The IMF forecasts that the global economy will contract by -4.4% in 2020 (IMF 2019). The fall in income predicts a substantial decline in living standards. WBG estimates that an additional 150 million people will live in extreme poverty in 2021 due to COVID-19 (Lakner, et al. 2020).
Latin America will be hard-hit. Six out of the ten countries with the highest mortality rates per million people are in the region, which concentrates 8.5% of the world’s population, but accounts for 28% of cases and 34% of deaths. The IMF forecast that the GDP in Latin America will fall 8.1%, almost doubling the global figure. The pandemic hit an economy already in trouble; in 2019, the Regional growth rate was 0%.
How this affects productivity?
Initially, the quarantine generated a supply shock, which led to a demand shock, and many companies had to close temporarily. The capital installed remained unchanged, and many employees were not fired but underutilized, staying on the payroll, while production efficiency fell abruptly. It is likely that those who telework will have lower productivity, although the evidence for this is not conclusive and depends on the type of work and the teleworking. Government lockdowns have also disrupted Global Value Chains and affected the supply of foreign and domestic inputs, impacting productivity.
Latin America is the region with the most stringent measures to combat the pandemic, and many of these measures severely affect productivity. The University of Oxford constructed a stringency index which records the strictness of ‘lockdown style’ policies that primarily restrict people’s behavior (including closings of workplaces, schools, and public transport, and restrictions of internal and international moves). Figure 1 depicts the index by region. Latin America’s index is the highest among all regions and continued at the top after six months of measures.
However, these effects are temporary as the quarantine unfolds and measures get relaxed, machines turn on, businesses open their doors, and employees return to their jobs. Although it is not yet clear how long this disruption will last in the region, at some point, firms will return to some degree of normality, and productivity will recover. This situation is more evident in Europe than in Latin America. While by March, measures in both regions had similar restrictiveness, by September, Europe’s strictness was almost half. Productivity in Latin America is probably still significantly below the pre-crisis level because the economies have not yet returned to a new normal.
Effects on the Medium-Run
Beyond the temporary and reversible short-term effects, this situation will likely generate medium-term impacts on productivity. Major adverse events—such as natural disasters, wars, financial crisis, and epidemiological disasters of the magnitude of this one—can have large, sustained adverse effects on productivity. Amid elevated uncertainty, epidemics have reduced labor productivity through their adverse impact on investment by tightening credit and decline in innovation and the labor force. The COVID-19 pandemic may be significantly worse than most past disasters because of its global reach and the unprecedented social distancing and containment measures to slow the spread of the virus (WB 2020).
COVID-19 affects firms’ productivity beyond short-term declines through various channels and mechanisms. The immediate need is to support firms as the outbreak unfolds, addressing liquidity bottlenecks and preventing massive layoffs and bankruptcies. As the sanitary situation comes under control, attention should shift to assisting firms in restructuring and adjusting to a ‘new normal’ and helping them embark on a sustainable recovery. By taking the right economic policy measures, this crisis can be an opportunity to increase productivity and sustain higher economic growth. The next and final section outlines some policy measures to boost productivity in the medium run.
Policy Measures and Recommendations
Response to past crises episodes provides a first approximation of the policies needed in the initial and long-run. The immediate response should consider measures to provide liquidity through new lending, partial credit guarantees, and rescheduling loan payments. It is also essential to reduce business costs, with tax relief, wage subsidies, and rescheduling of utility payments.
Governments worldwide have launched an extensive array of measures to support firms and jobs. Many of them targeted specifically at small and medium-sized enterprises (SMEs). The WBG tracks SME-support actions in response to COVID-19. Its database collected almost 1150 measures rolled out by 124 countries. On average, a country has instrumented more than nine measures to support SMEs. The preferred types of policy responses are debt finance, employment, and tax support (see figure 2).
The level of response in Latin America has been modest. The University of Oxford also constructs an economic support index that records income support for households, debt relief, and fiscal measures. Figure 3 shows that Latin American Governments’ financial support started later and has been lower than the support provided by European countries and the US. However, in Latin America, the support has been higher than in Asia and Africa.
When designing and implementing effective and timely responses, it is suggested (Freund and Garcia Mora 2020) that policymakers must keep the following considerations in mind when supporting firms:
a) Focus on supporting firms and jobs, both to help workers but also to prevent long-term damaging that would come as firms go bankrupt.
b) Limited fiscal capacity constrains the reach of policy responses. The pandemic could exacerbate the challenges of managing high levels of corporate and government debt.
c) Ensure that emergency measures are transparent and time bound. It is critical to avoid time-consistency problems and capture by communicating convincingly and transparently the rationale for supporting firms and the duration of policy interventions, with clear and credible sunsets.
d) Increase targeting over time, going from broad-based responses at first to support policies that focus on a specific group of beneficiaries, with the objective of steering resources toward more productive firms.
Post-crisis responses should focus on stimulating productivity-driven economic growth via investment financing, supporting investments in digital technology, regulatory flexibility, debt restructuring, and an enhanced liquidation process (Cruz, et al. 2020). It is also crucial to ensure the continuity of trade in goods and services to enable companies to source quality inputs and reintegrate into the Global Value Chains.
It is essential to guarantee the fluid reallocation of resources between sectors by reducing distortions and obstacles that affect the mobility of capital and promoting training policies for unemployed personnel, allowing them to reintegrate into more dynamic sectors of the economy with newly acquired skills.
Finally, Governments should continue protecting SMEs, which are the most vulnerable in this crisis. In regular times, firm closures allow the reallocation of resources to more productive firms. COVID-19 threatens to force many otherwise viable firms into bankruptcy. As firms shut down, valuable intangible assets are destroyed and cannot be easily and immediately reestablished, leading to a protracted period of low growth and unemployment (Rama and Lankes 2020). To prevent such damage (and mitigate possible social outbreaks), policies in response to COVID-19 should focus on protecting jobs by keeping firms afloat. Governments should prevent young enterprises’ departure with productive potential that may not survive without adequate protection policies.
To conclude, this pandemic has exposed all the endemic problems of the region. But it represents an opportunity to rethink our growth model and design reforms to grow more and better sustainably. Pulling Latin America out of this unprecedented economic crisis calls for giving a more prominent role to measures aimed at addressing the region’s lagging productivity. At the heart of the recovery is the need for addressing productivity growth.
~ Pablo Fleiss is IMPACTO’s Economic Policy Expert
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Freund, Caroline, and Alfonso Garcia Mora. “Keeping the lights on: Supporting firms and preserving jobs from crisis through recovery.” Private Sector Development Blog. World Bank Group, 2020.
Hsieh, Chang-Tai, and Peter J. Klenow. “Development Accounting.” American Economic Journal: Macroeconomics 2(1), 2010.
IDB. The Age of Productivity: Transforming Economies from the Bottom Up. Washington, DC: Inter-American Development Bank, 2010.
IMF. World Economic Outlook, October 2020: A Long and Difficult Ascent. International Monetary Fund, 2019.
Kim, Young Eun, and Norman V Loayza. “Productivity Growth : Patterns and Determinants across the World.” Policy Research Working Paper 8852, 2019.
Lakner, Christoph, Nishant Yonzan, Daniel Mahler, Andres Castañeda, Haoyu Wu, and Melina Fleury. “Updated Estimates of the Impact of COVID-19 on Global Poverty: The Effect of New Data.” World Bank Data Blog, 2020.
Rama, Martin, and Hans Peter Lankes. “The Economic Policy Response to the COVID-19 Crisis.” World Bank Group, 2020.
WB. Protecting People and Economies: Integrated Policy Responses to COVID-19. Washington, DC: World Bank Group, 2020.
World Bank Group. “Global Economic Prospects, June 2020.” Washington, DC, 2020.