Firms in emerging markets have suffered at least as much from Covid-19 as those in advanced economies. Evidence suggests that they have cut investment rather than laying-off staff. They have also been flexible with suppliers and business partners, and tried to support their communities.
The economic fallout from the pandemic has been severe, with whole industries having to shut for extended periods, plants sitting idle and firms being cut off from suppliers and customers alike.
But both theory and empirical evidence suggest that there are critical differences between firms in advanced economies and emerging markets in the impact of the pandemic and in firms’ reactions. This article explores these differences and provides some empirical evidence based on firm-level surveys and share price reactions.
The impact of the pandemic on developing economies
First, take the impact of the pandemic. Disruptions in supply chains and the drop in international demand were often the first negative signals before the public health crisis reached many developing countries.
Many advanced countries reacted with lockdown policies that brought a large part of the economy to a standstill, including industries that rely on direct customer contact but also manufacturing and construction in some countries. Among emerging markets, there has been variation in responses, with some countries going for strict lockdowns, such as Vietnam, while others have kept their economies relatively open, such as Turkey.
Differences in the timing and severity of lockdown policies have implications for firms and their employees. More generally, higher informality, fewer jobs that can be done from home and more limited state capacity make both public health-oriented containment and enforcement less effective, while limited fiscal space and limited access to international financial markets make economic support policies more difficult to implement (Djankov and Panizza, 2020).
The trade-off between public health and economic survival is therefore more biased towards the latter in many emerging markets.
How long can firms survive?
Second, firms might be less prepared for the impact of the pandemic in developing markets. For example, using enterprise survey data across 12 high- and middle-income countries and based on the ratio of net retained earnings for the past year plus credit availability for firms to fixed costs such as rent, machinery maintenance, and cost of materials, Bosio et al (2020a) find that, without revenues, the median firm has liquidity to survive between eight weeks (in construction) and 19 weeks (in other manufacturing). These are conservative estimates as the assumption is that wages and other employee expenses are covered fully by government crisis-response programmes.
Using similar data across 34 low- and lower-middle-income countries, Bosio et al (2020b) find for firms in low-income countries, that the median survival time across industries ranges from six weeks (in retail) to 28 weeks (in manufacturing), and six and 18 weeks once collapsed export demand is taken into account.
It is important to stress that in such countries, it is even less likely that the government will be able to cover employment-related costs, so that these estimates are even more conservative than for middle- and high-income countries.
Beyond the medians across sectors, there is also substantial country variation. For example, the median manufacturing firm in Myanmar has a survival time of seven weeks, whereas the median firm in the same sector in Liberia can last 36 weeks.
How can firms react?
Third, firms might react differently in emerging markets, given the institutional frameworks and business environments in which they operate. On the one hand, investment plans can be cancelled rather quickly: such a reaction might reflect firms’ assumption that there will not be a V-shaped quick recovery but rather a drawn-out crisis or loss of access to external funding.
On the other hand, many emerging markets’ labour markets are often considered more flexible than those of advanced countries, so that quick reductions of payrolls are another option to reduce costs. But relationships between firms and their stakeholders, such as employees, customers, suppliers and society at large, are often based not only on contractual but also on informal and personal links. This implies that firms can react quickly and reduce commitments, but they might also have to worry about long-term implications of undermining important relationships with business partners and stakeholders.
What do the data show?
Based on survey responses and stock market reactions across 488 listed firms in ten emerging markets, Beck et al (2020) find that at least three in four firms have been negatively affected by the pandemic. Yet when asked in April, surprisingly few firms expected to breach their covenants or saw a need for raising additional capital.
About half of the firms have received or expect to receive government support. Firms have reacted primarily by reducing investment spending and much less through layoffs. Meanwhile, some firms cut back on executive compensation, and more firms expanded employee benefits than cut them.
Firms not only protected their labour force from the impact of the pandemic, but they have also shown flexibility vis-à-vis customers and stakeholders, providing donations to support society at large or shifting business operations to fulfil pandemic needs.
This shows a picture of firms focusing on short-term needs of stakeholders and protecting labour and long-term relationships. This is not a picture consistent with short-term focused shareholder maximisation value, but rather one focused longer-term value maximisation for both shareholders and other stakeholders.
How have share prices reacted?
The impact of the pandemic shock is also reflected in share prices, although in a delayed manner, inconsistent with the semi-strong form of market efficiency, but consistent with less liquid and thus efficient financial markets in developing economies.
Strikingly, stakeholder-centric responses as described above are associated with positive share price reactions, suggesting that the financial markets reacted positively to firms helping their employees, suppliers and broader community. This is consistent with the importance of long-term relationships in these economies.
As the pandemic crisis continues to unfold, collecting data on how firms react is important. While financial statement information is backward-looking and available with delays, survey responses provide one useful way to gain a picture of the effects of the crisis and how firms have reacted to it.
Initial survey evidence suggests that firms in emerging markets reacted quickly and often even before governments. They focused on accommodating their labour force and maintaining long-term relationships with stakeholders.
Where can I find out more?
- COVID-19 in emerging markets: firm-survey evidence: A study by Thorsten Beck, Burton Flynn and Mikael Homanen published in COVID Economics 38, 16 July.
- Survival of firms during economic crisis: World Bank research by Erica Bosio, Simeon Djankov, Filip Jolevski and Rita Ramalho.
- Survival of firms in developing economies during economic crisis: A report by Erica Bosio, Filip Jolevski, Joseph Lemoine and Rita Ramalho, which appears in Covid-19 in Developing Economies edited by Simeon Djankov and Ugo Panizza, an eBook published by the Centre for Economic Policy Research (CEPR) and VoxEU.
- Covid-19 in Developing Economies: The CEPR eBook bringing together short pieces from top economists on a wide range of issues related to the pandemic and developing countries.
Who are experts on this question?
- Thorsten Beck (Banking and corporate finance in emerging markets)
- Simeon Djankov (Institutions in emerging markets)
- Anne Brockmeyer (Public and development economics)