People at rush hour, Bangkok, Thailand, 18 March 2020
People at rush hour, Bangkok, Thailand, 18 March 2020. (Image: Tzido via iStock photo)

How to minimize the negative impact on industry

Resolute policy action is required to sustain productive capacity and mitigate supply and demand shocks.

By Nobuya Haraguchi

COVID-19 has triggered an extraordinary health crisis in every corner of the globe. As the pandemic continues to spread countries are ‘learning by doing’ on how to contain the highly contagious virus. At the same time, this health emergency has also caused an unprecedented economic crisis. The current situation differs from the past economic crises, including the most recent global financial crisis in 2008. 

The 2008 financial crisis was caused by asset and financial bubbles which posed a systemic macroeconomic risk. 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, and closure or reduced operations by administrative order.

The impact of COVID-19 is felt both on the demand and supply side simultaneously. By contrast, the global financial crisis spread from advanced countries to developing ones through foreign trade and investment linkages. Thus, 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.

The COVID-19 crisis shows its impact at the same time both globally and locally. 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 financial crisis, shocks are also directly originating from domestic sources like the closure of businesses and a decrease in consumer demand due to economic uncertainty.

Since such direct shocks arise as COVID-19 spreads to developing countries, the time lag between the impacts on advanced and developing economies becomes much shorter, if not simultaneous. This is yet another difference to the global financial crisis where it took six to nine months for the impact to be felt in developing countries.1 High income countries recorded a decline in manufacturing value added in 2008, while the impact in developing regions, if any, only emerged in 2009.

Manufacturing value added in high income and developing countries

Source: UNIDO MVA 2019

The need to mitigate damage to industries

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. 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. Furthermore, the disruption of supply chains affects 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.

Consequently, the government as insurer of last resort must act decisively in order to save firms and the livelihoods of its population, and prevent long-lasting damage to the economy. 

The global financial crisis affected the production of consumer durable goods, such as electrical machinery and equipment (see charts below). In Italy, for instance, the crisis caused a significant 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.2

Effects of 2008 financial crisis on establishments and production in Italy

Note: This chart depicts trends in the number of establishments and production in the electrical machinery and equipment industry in Italy.

Source: UNIDO INDSTAT 2 2020

Effects of 2008 financial crisis on establishments and production in Germany

Note: This chart depicts trends in the number of establishments and production in the electrical machinery and equipment industry in Germany.

Source: UNIDO INDSTAT 2 2020

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

While the 2008 financial 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. 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 2010.3

Production of wearing apparel in Bangladesh

Source: UNIDO INDSTAT 2 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 March 2020 survey of 316 garment suppliers, the Center for Global Workers’ Rights documented the devastating impact on the industry of around four million workers. More than one million workers have been laid off or furloughed due to order cancellations and failure of payment by buyers for those cancellations. Eighty per cent of the dismissed workers did not receive severance pay from their employers.4 Due to buyer cancellations, more than half of respondents indicated that the majority of operations had been shut down. 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.56

Other major apparel exporting countries in Asia are facing similar situations. The Nikkei Asia Review 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.7 The apparel and textile industries are the major source of manufacturing jobs in many developing Asian countries, especially for women.

Employees sanitise hands before entering office, Guwahati, India, 21 April 2020
Employees sanitise hands before entering office, Guwahati, India, 21 April 2020. (Image: D. Talukdar via iStock photo)

A loss of a firm or factory 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 foods from street vendors, which in turn leads to the loss of incomes for vulnerable populations whose livelihood often depends on such informal jobs. 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 as a whole, leading to more factory closures and higher unemployment, with significant negative implications for vulnerable groups.

What policies need to focus on

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, financial support should be provided to firms, especially SMEs, so they do not have to lay off workers and can continue paying salaries. This should be 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.8 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. It is important to contain the problem at the microeconomic 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.

Developing countries, especially low-income countries, cannot be expected to 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 are 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 credit 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 guidance 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.

  • Nobuya Haraguchi is Chief of the Research and Industrial Policy Advice Division at the Department of Policy Research and Statistics (PRS) of the United Nations Industrial Development Organization (UNIDO).

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).

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