Rescue industries and firms now: How to minimize the long-term negative impacts on economies and populations

Cover image: Tzido via iStock photo

Opinion piece by Nobuya Haraguchi

April 2020

Key messages:

• The failure of industries and firms will inflict long-term irreversible damage on economies and populations, particularly vulnerable populations. Rescuing industries and firms now will help them recover quickly from the crisis and minimize economic costs in the long term.
• The COVID-19 crisis started as a microeconomic problem unlike the 2008 financial crisis. It should be contained at that level. A spillover to the financial sector will turn it into an aggregate macroeconomic problem, making recovery all the more difficult.
• Support households and people through existing employer-employee relationships by helping firms continue to pay wages and salaries despite reduced operations or temporally closures to reinforce both demand and the maintenance of supply capacity.

Differences in economic impacts between the COVID-19 crisis and the 2008 financial crisis

COVID-19 has triggered an extraordinary health crisis across every corner of the globe. As the virus spreads across borders, countries are ‘learning by doing’ on how to contain the highly contagious virus and how to cope with the tremendous medical and administrative challenges to protect their citizens. At the same time, this health emergency has also caused an unprecedented economic crisis. The current economic crisis differs from the 2008 financial crisis, especially for developing countries. Firstly, the 2008 crisis was caused by asset and financial bubbles which posed a systemic macroeconomic risk. Once the bubbles burst, the rapid deterioration of economic conditions exposed the operational and financial weaknesses of uncompetitive firms, such as US automotive firms, hence transmitting the shocks to real economies. By contrast, the COVID-19 crisis poses a microeconomic problem for real economies. Firms that under normal circumstances are sound and healthy are suddenly facing the severe negative impacts of the crisis due to lack of supplies and demand, closure or reduced operations of their businesses by administrative order. If we fail to contain this microeconomic problem within the real economy, there is a possibility that it might spill over to the financial sector through liquidity constraints and turn into an aggregate macroeconomic problem, which would cause a downward spiral, further aggravating the volatile situation of firms and households.

Secondly, the impact of COVID-19 impacts both the demand and supply side simultaneously. The sudden closure or reduced operations of factories and shops, and restrictions on people’s movements has increased economic uncertainty considerably, dampened economic prospects and reduced real incomes and spending, while suddenly curtailing the production of goods and services. By contrast, the 2008 financial crisis spread from advanced countries to developing ones through foreign trade and investment linkages. Thus, as illustrated in Figure 1, regions with relatively limited economic integration in global markets and production at the time, such as South Asia and sub-Saharan Africa, were not severely impacted. Even Southeast Asian countries (ASEAN), which played a role in regional supply chains, were able to recover from the crisis within a few years because they managed to keep their production capacities intact.

Figure 1: Manufacturing value added of high-income countries and developing regions (2000-2018)

Source: UNIDO, 2019

Finally, the 2008 crisis was a global crisis in the sense that its impacts spilled over from advanced economies to other countries. In developing countries, the financial crisis primarily affected companies operating in global supply chains and the regions in which they were located. The shocks in the manufacturing sector varied from industry to industry, with the most severe impact on consumer durable goods industries, and less so on consumer non-durable goods such as wearing apparel, and least on domestic-oriented industries, namely food and beverages (UNIDO, 2020; UNSD, 2020). The COVID-19 crisis, however, is both global andlocal. The shocks are more ubiquitous in terms of location and industries. While demand and supply shocks from advanced and emerging countries have impacts on companies participating in global supply chains similar to the 2008 crisis, shocks are also directly originating from domestic sources like the closure of businesses or reduced operations following government orders and a decrease in consumer demand due to economic uncertainty. Unlike the financial crisis, therefore, large companies and SMEs alike—whether in cities, suburbs or villages—could face deterioration of their businesses. Since such direct shocks arise as COVID-19 or the fear of the virus spreads to developing countries, the time lag between the impacts on advanced and developing economies is much shorter, if not simultaneous, than the time it took for the impacts to be felt during the 2008 crisis, namely six to nine months later, from the last quarter of 2008 onwards (UNIDO, 2009). Thus, as Figure 1 shows, high-income countries recorded a decline in manufacturing value added in 2008, while the impact in developing regions, if any, only emerged in 2009.

The need to mitigate damage to industries

Because the current crisis differs from the 2008 financial crisis, the response to the pandemic’s impacts must take the specific characteristics of the COVID-19 crisis into consideration. The primary objective of policy responses should be rescuing existing firms and industrial ecosystems, because they drive the value creation of countries and generate employment and incomes for households (see Figure 2). Many firms are currently facing problems not because of their underlying financial weaknesses or uncompetitive operations, but due to temporary severe shocks which originated outside the realm of their businesses. Under normal circumstances, they would not be distressed by the burden of debt (such as firms in advanced countries during the financial crisis), downsizing their operations or filing bankruptcy, but making profits and distributing value added to households and governments in the form of incomes and taxes, respectively. However, if they do not survive the current turmoil, many healthy firms will not be able to resume their business operations after the crisis and jobs and incomes will be permanently lost. Furthermore, the disruption of supply chains would affect supplier and customer firms, resulting in reduced wages and employment, as well as lower household incomes. Such episodes resulting from the collapse of firms at the micro level would, in total, reduce aggregate demand for goods and services in the economy and lead to an increase in non-performing loans and liquidity constraints in the financial market. The deterioration of the macroeconomy could add pressure on companies that are already in dire straits and could create a snowball effect of mass bankruptcy and unemployment, further reinforcing the downward spiral between micro and macro interactions.

Figure 2: Firms as the locus of value creation and the source of livelihoods. (The public sector is not included in Figure 2 to emphasize the government as the last resort and source of counter-cyclical measures.)

Source: Author

Consequently, the market completely fails because prices cannot coordinate business transactions when demand and supply are regulated by non-economic forces. To prevent a pro-cyclical downward spiral as illustrated in Figure 2, the government as insurer of last resort must act decisively in order to save firms and the livelihoods of its populations, and prevent long-lasting damage to the economy.

As Figure 3 shows, the 2008 financial crisis affected the production of consumer durable goods, such as electrical machinery and equipment. In both France and Italy, the crisis caused a massive exodus of firms from the electrical machinery and equipment industry, accelerating the reduction of employment. The loss of firms and jobs inflicted long-term, if not permanent, damage on the industry and made it difficult for this key manufacturing industry to recover to its pre-crisis level of production. By contrast, Germany managed to minimize the damage to firms and their exit from the industry, allowing the electrical machinery and equipment industry to recover quickly from the crisis and ensuring that the industry remained an important long-term source of employment and household incomes in the country. (The level of employment in 2011 exceeded the 2008 level, and in 2010, the industry recovered to the 2008 level of wages and salaries (UNIDO, 2020)). 

Figure 3: Trends of establishments and production in the electrical machinery and equipment industry in France, Italy and Germany

Source: UNIDO, 2020

The impact of COVID-19 on developing countries and vulnerable populations

While the 2008 crisis had severe long-lasting impacts on consumer durable industries of some countries, its impact on consumer non-durable industries was relatively mild, especially in developing countries. As shown in Figure 4, the crisis had a limited impact on production in Bangladesh’s wearing apparel industry, one of the world’s major manufacturers and exporters of textiles. After experiencing a delayed small shock in 2009, the country’s wearing apparel industry quickly resumed growth at the pre-crisis rate after 2010. (The industry has a very limited number of data points for other variables such as the number of establishments and employees. The most recent year for which data on these variables is available is 2012. No data are available from 1998 to 2012. Between those years, the number of establishments and employees increased three-fold and 2.8-fold, respectively.)

Figure 4: Production trend in Bangladesh’s wearing apparel industry

Source: UNIDO, 2020

Current evidence, however, indicates that the impact of the COVID-19 crisis on Bangladesh’s wearing apparel industry is different from that of the 2008 financial crisis. Based on a survey of 316 garment suppliers (from 15 to 25 March 2020), the Center for Global Workers’ Right documented the devastating impact on the industry of around four million workers, reporting that already more than one million workers have been fired or furloughed due to order cancellations and failure of payment by buyers for those cancellations. Due to buyer cancellations, 53.4 per cent of respondents indicated that the majority of operations had been shut down. Eighty per cent of the dismissed workers did not receive severance pay from their employers (Center for Global Workers’ Right, 2020). On 26 March, the Bangladesh Garment Manufacturers and Exporters Association (with 4,500 registered factories) recommended all its member factories to keep their factories closed initially until 4 April and later extending the measure to 25 April (Financial Express, 26 March and 10 April 2020). Other major apparel exporting countries in Asia are facing similar situations. The Nikkei Asia Review (3 April 2020) reported that at least 20 apparel factories had halted operations due to fabric shortages in Myanmar, while in Cambodia, 91 factories suspended their production, affecting 61,500 workers. The apparel and textile industries are the major source of manufacturing jobs in many developing Asian countries, especially for women.

A loss of a firms or factories can have extensive impacts on the lives beyond those who are directly employed in the firm, including many vulnerable persons who eventually benefit from the firms’ production and wealth distribution. When a worker loses his job, for example, he and his family will likely need to reduce their spending on domestic services and buy foods from street vendors, which in turn leads to the loss of incomes for vulnerable populations whose livelihood often depends on such informal jobs. Or if a small financially weak firm files for bankruptcy, a worker whose monthly wage is the family’s only income source loses her job and she will no longer be able to pay rent, sustain her children’s education and buy medication for her sick parents. In another example, a migrant worker, whose job status in the host country is insecure, may be the first to be laid off when her company comes under financial strain. Consequently, her family back home, who depends on her monthly remittance, could plunge into extreme poverty. Such examples demonstrate that rescuing industries and firms is of paramount importance for workers and their households, as well as for vulnerable populations who are at the fringe of the industrial ecosystem but who are certainly beneficiaries of firms’ value adding activities. The collapse of a firm in the manufacturing sector—which often has more extensive linkages in value chains than other sectors—could multiply the negative impacts on people, as the operations of both customers and suppliers would be disrupted, which in turn could undermine the smooth functioning of the industrial organization on the whole, leading to more factory closures and higher unemployment, with significant negative implications for vulnerable groups (Figure 2).  

What policies need to focus on

The termination of an employer-employee relationship has long-term implications for the employability of those who lost their job (CEPR, 1985). Like physical capital, human capital also depreciates, perhaps faster than physical capital. Unlike physical capital, however, human capital tends to be more valuable for the current employer than for others because part of the human capital has value in the firm-specific context only, as it was acquired by the worker during her employment in the given company. Being unemployed, especially during a crisis that sets off a certain period of very limited employment opportunities, workers’ employability declines even in the period following the crisis. As has been experienced in the electrical machinery and equipment industries in France and Italy (Figure 3), a loss of firms can inflict permanent damage on and hardship for the industries and workers directly, and by default for their dependents, and vulnerable persons, who are at the margins of society. Unlike the 2008 financial crisis, the possibility of such a catastrophe is now real and imminent for developing countries. Unless we take immediate action to rescue industries and firms, the long-term impacts on the economies and on populations bode ill for achieving the 2030 Agenda we set forth in the last decade.

To not only quickly recover from the crisis but to also ensure it is feasible, the key is employment retention and maintenance of industrial relationships to the extent possible. Providing financial support to people and households through the current employer-employee relationships will help both demand and the maintenance of supply capacity. While direct cash transfers will be necessary for those who are currently unemployed or struggling to make ends meet, financial support should be provided to firms, especially SMEs, so they do not have to lay off workers and can continue paying salaries, even during periods of factory closures rather than to provide unemployment benefits afterwards to those who have lost their job. This is undoubtedly an expensive programme, but it is likely to pay off in the long term, just like the German government’s support for firms proved successful for fast recovery from the 2008 financial crisis (Nihon Keizai Shimbun, 20 April 2020). While the focus would foremost be on employment retention, the government could take a strategic approach in its industrial support, using the crisis as an opportunity to help build a more inclusive and sustainable industrial structure for the post-COVID-19 period.

Another key policy is financial sector support measures to maintain liquidity and to ease the financial burden of firms, especially SMEs, which are already facing significant challenges. As shown in Figure 2, it is important to contain the microeconomic problem at the micro level and address it before it spills over to the financial sector. If the bankruptcy and default of firms and households leads to a meltdown in the financial sector, the economic crisis unleashed by COVID-19 moves to another level, namely a financial crisis, which will sap the vitality of economies and make a fast recovery far more difficult.

Even though industrial production could in principle resume in a relatively short period of time as the case of China has demonstrated, developing countries, especially low-income countries, cannot shoulder the burden to sustain their physical and human capital on their own.Coordinated actions among governments, donors, international organizations, the private sector and NGOs is much more urgent for developing countries than they are for advanced countries. The strongest link in supply chains, such as multinational corporations and large domestic firms, should at least honour the payments for orders they have already placed and possibly provide credits to SMEs in the supply chain to retain production capacity. Governments need to be aware of changing financial conditions of firms and continuously update the information to channel the right amount and the type of support firms require from the government and donors. NGOs and charity organizations could play a key role in reaching out to informal firms in rural areas and provide customized support based on their long-term experiences in serving rural communities. International organizations like UNIDO can provide policy and technical advice and help governments coordinate the actions of different stakeholders. Unless the international community provides support to industries and firms in developing countries now, their need for assistance will likely skyrocket in the long term.

Disclaimer: The views expressed in this article are those of the authors based on their experience and on prior research and do not necessarily reflect the views of UNIDO (read more).