How Asia Can Ease Scarring from Lower Investment, Employment and Productivity

IMF Blog, March 31, 2023

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Asia is expected to experience an average gross domestic product loss of 9.1 percent through next year, measured by comparing 2022 forecasts of growth to projections made in January 2020.
Emerging and developing economies in the region are expected to suffer greater losses than the regional average.
Investment losses account for a quarter of the region’s expected output losses.
Investment as a share of GDP is expected to be 3 percentage points lower next year in emerging economies versus pre-pandemic projections.
Lower job growth would contribute about 2 percentage points to output losses in Asia.
Productivity growth accounts for about half of Asia’s scarring.

Asia has historically high corporate debt, which increased further during the pandemic and is especially elevated in emerging economies compared to other regions.
Businesses with higher borrowing are less likely to expand or invest because additional investment would add servicing costs to existing obligations, reducing overall capital spending and growth.
Using a detailed database of corporate balance sheets, the research finds that recessions have a large and persistent negative effect on firm-level investment, with the effect greater for high-debt firms.
Highly indebted firms, on average, see investment fall by 6 percent more than low-debt firms three years after a recession.
Greater borrowing alone accounts for at least 28 percent of the average drop in investment after recessions.
Smaller and less profitable firms with high debt tend to see the biggest investment declines, reflecting difficulty securing external funding without collateral and limited internal funds to finance investment.

Employment could remain depressed for many years because of both the long-term loss of labor force quality and the reduced quantity of workers.
Protracted school closures caused severe learning losses among students, with classrooms closed longest in Asia’s low-income economies; these education losses are expected to significantly hamper acquisition of valuable skills and lower long-term productivity.
Pandemics can reduce fertility rates: epidemics over the past two decades, though smaller in scale, led to persistent declines in fertility rates of about 2.5 percent, suggesting the COVID crisis may reduce the number of people entering the workforce.

Digitalization can be essential to boosting slowing productivity growth and limiting scarring.
Pre-pandemic data show that firms in more digital-oriented industries see a smaller decline in revenues following a recession than other firms.
During the pandemic, labor markets favored digital sectors: high-frequency data from job sites like Indeed and LinkedIn shows that digital jobs remained robust and recovered more quickly, even in emerging economies.
Promoting digitalization is especially important in emerging economies, which have generally lagged advanced economies in online commerce, patents, and other digital innovation.
Enhancing digital connectivity should be a priority, especially in low-income developing countries, and for disadvantaged groups and regions.

Prioritize an orderly reduction of corporate sector debt to improve resilience to future shocks.
Reform insolvency frameworks to allow reallocation of resources to more productive firms.
Assess learning setbacks from school closures and invest in teaching marketable skills to students; this may require more in-person training or longer school years.
Implement retraining and other programs to return people to the workforce, which would deliver economic benefits.
Promote digitalization across firms and industries to connect with customers and employees, support remote work and online sales, and build resilience against future shocks.
Focus digitalization efforts on emerging and low-income economies and disadvantaged groups to raise productivity growth and limit scarring.

Asia could suffer significant long-term output losses from COVID-19 due to diminished investment, productivity growth, and labor force participation.
Economic reforms are essential to mitigate scarring: address investment scarring from high corporate debt through deleveraging and insolvency reforms, mitigate education losses, and accelerate digitalization.
With a bold, concerted push, economies in the region can return to growth and better protect themselves against future shocks.

Source: How Asia Can Ease Scarring from Lower Investment, Employment and Productivity (IMF blog, March 31, 2023)