The COVID-19 crisis has opened deep economic scars in the Asia and Pacific region that are unlikely to heal even in the medium term. The first section of this chapter documents the expected magnitude of output losses and sheds light on the factors contributing to this phenomenon, highlighting the role of lower investment, employment, and productivity growth. Next, the chapter does a deep dive into the factors that are especially relevant for Asia in influencing the magnitude of output losses. First is the high level of nonfinancial corporate debt in Asia, which is expected to drag investment down in the medium term. Second is the role of education losses and the decline in fertility in reducing labor growth in the long term. Finally, the chapter focuses on policies to mitigate these scarring effects. Although reform priorities will depend on country-specific circumstances, tackling the corporate debt overhang and mitigating human capital losses will be key for many countries in the region. In addition, digitalization has emerged as a focus area in the aftermath of the pandemic, and faster adoption can boost productivity and improve resilience.
Expected Output Losses after the COVID-19 Crisis: Magnitudes and Determinants
The short-term economic losses from the COVID-19 pandemic were the largest since the Great Depression, as stringent lockdowns and disruption of supply chains led global GDP to contract by 3.3 percent in 2020. Given the unique and protracted nature of the crisis, coupled with additional shocks (most notably the Russian invasion of Ukraine), output losses are likely to persist.
Indeed, according to the latest IMF projections, global medium-term output losses—computed as the percent deviation between prepandemic (January 2020) and latest GDP projections for 2024—are expected to be about 5.3 percent on average (Figure 2.1, panel 1). Losses are expected to be much larger in emerging market and developing economies (6.3 percent) than in advanced economies (1.4 percent), and across regions, more pronounced in Asia (9.1 percent). Losses in Asian emerging market and developing economies are much larger than other emerging market and developing economies (11 percent versus 5 percent), while losses for Asian advanced economies are expected to be similar to other regions (Figure 2.1, panel 2). Within Asian emerging market and developing economies, there is significant heterogeneity in expected output losses, with tourism-dependent countries (Pacific islands, Maldives, Philippines, Thailand) experiencing larger losses on average, potentially reflecting effects from bankruptcies and permanent closures of tourism-dependent businesses and structural shifts in travel, especially business travel. Several Asian emerging market and developing economies also had more stringent lockdowns than average, and while the lockdowns helped contain the spread of the virus, they have also been associated with larger output losses (India, Philippines).1
The magnitude of medium-term output losses is similar when using different forecast sources such as the Economist Intelligence Unit or Consensus Forecasts, with Asian emerging market and developing economies consistently showing the largest losses. Calculating output losses by using average GDP growth from 2015 to 2019 as the benchmark instead of prepandemic projections also yields similar results, indicating that potential optimism regarding prepandemic GDP projections is not responsible for the large expected losses (Figure 2.1, panel 3).
Furthermore, output losses are likely to persist in the long term: Most of the estimated medium-term decline in output after the pandemic is because of an envisioned decline in potential output (Figure 2.1, panel 4), suggesting that output losses will likely persist unless countries implement reforms to push supply. Indeed, while long-term forecasts are inherently more uncertain, 10-year-ahead projections available from Economist Intelligence Unit and Consensus Forecasts indicate protracted output losses in the long term: by 2029, output is expected to remain well below (more than 6 percent) prepandemic trends for Asian emerging market and developing economies.
To identify the channels through which scarring is expected to occur, the chapter employs a growth decomposition approach using historical and forecast data to quantify the contributions of capital stock, employment, and total factor productivity in expected output losses. The results suggest that the direct contribution from lower capital accumulation is about 1.8 percent for Asia and about 3 percent in Asian emerging market and developing economies. To the extent that lower investment is likely to reduce total factor productivity growth in the future and considering the difficulty in accurately measuring and projecting capital stock, the true contribution of lower capital accumulation is likely larger. Lower employment growth contributes about 2 percent to expected output losses in emerging market and developing economies and 1.2 percent in Asian advanced economies. The residual is attributed to losses in total factor productivity (Figure 2.1, panel 5).
The next sections explore some of these factors affecting the persistent decline in investment and employment.
Lower Investment in Asia: The Role of Corporate Debt in Amplifying Output Losses
Investment in Asia is expected to be reduced significantly after the COVID-19 pandemic: compared with prepandemic projections, investment as a share of GDP in 2024 is expected to be more than 3 percentage points lower in Asian emerging market and developing economies, compared with only a 0.5 percentage point decline in other regions (Figure 2.1, panel 6).
While cyclical conditions—such as lower demand, heightened uncertainty, and the global rise in interest rates seen in 2022—are the key contributors to the decline in investment in the short term, one key structural factor is likely to contribute to investment scarring in Asia: the elevated level of nonfinancial corporate debt.
Indeed, high corporate leverage has been typically found in the literature to be associated with lower levels of capital spending, as highly leveraged firms find it more difficult to finance investment projects (for example, Myers 1977; Campello, Graham, and Harvey 2010; Albuquerque 2021; April 2022 World Economic Outlook), and the current crisis occurred in a context of historically high nonfinancial corporate debt in Asia—much higher than in other parts of the world, especially in Asian emerging market and developing economies (Figure 2.2, panel 1). While China has one of the highest levels of corporate debt among emerging market and developing economies, average leverage in the ASEAN and South Asian countries was also higher than the global emerging market and developing economies average heading into the crisis.
Corporate Debt and Education Losses during COVID-19: Implications for Asia
Corporate Debt and Education Losses during COVID-19: Implications for Asia
Corporate Debt and Education Losses during COVID-19: Implications for Asia
Corporate Debt and Education Losses during COVID-19: Implications for Asia
Corporate Debt and Education Losses during COVID-19: Implications for Asia
Corporate leverage has increased further after the pandemic. The increase has been large in Asian advanced economies and emerging market and developing economies, rising by about 6 percent of GDP on average between 2019 and 2021 (Figure 2.2, panel 2).2 It has also been concentrated in industries such as consumer services and transportation that were worst hit by COVID-19, while less-hit industries (like pharmaceutical and biotechnology firms, semiconductor producers) recorded a contraction in their debt levels (Figure 2.2, panel 3). This divergence is starker in emerging market and developing economies than in advanced economies, with leverage ratios higher by an additional 1 percentage point in the worst-hit industries in emerging market and developing economies, as government financial support was also likely lower for these firms during the pandemic.
To quantify the potential role of corporate leverage in shaping medium-term investment losses from the crisis, the chapter uses a rich and novel firm-level quarterly database to assess the scarring effect of high corporate debt on investment after recessions.3 The results suggest that while recessions have a large negative and persistent impact on firm-level investment in the medium term, this effect is especially larger in highly indebted firms: investment declines by an additional 2.5 percentage points within four quarters of the beginning of a recession in high-debt firms relative to low-debt firms, with the effect increasing to more than 5 percentage points by 12 quarters (Figure 2.2, panel 4). These results and back-of-the-envelope calculations suggest that that firms’ debt accounts for at least 28 percent of the average medium-term decline of investment after past recessions.
The results also suggest that the decline in investment is larger for high-debt firms that are smaller in size, less profitable, and with a higher share of short-term debt. This likely reflects difficulty in raising external funding because of lack of collateral, limited internally generated funds, and problems in rolling over debt, respectively, making it more difficult to invest in new projects (Figure 2.2, panel 5).
Finally, early data suggests that the role of corporate debt—the differential impact for high-debt firms versus low-debt firms—has been more than two times larger during the pandemic, possibly because of the high level of corporate debt heading into the crisis and the large magnitude of the shock.
Decline in Labor Inputs in Asia: Implications for the Long Term
Another concerning trend after the pandemic is the decline in employment growth, which is expected to contribute to output scarring in Asia by 1.5 percentage points. Different factors contribute to employment scarring. In advanced economies, the decline in employment is mainly driven by a lower population, as border closures brought migration to a standstill in countries like Australia and New Zealand. Meanwhile, in emerging market and developing economies, the main driver is lower labor force participation, potentially caused by worker disengagement and greater economic dislocation, which highlight the risk of long-term losses in employment for the economies.
Scarring via the employment channel is likely to persist beyond 2024 as the quantity and quality of the labor force may decline in the very long term. Regarding the quality of the labor force, education losses engendered by protracted school closures are expected to lead to significant losses in human capital and therefore productivity in the long term (April 2022 World Economic Outlook, Chapter 2). This is particularly concerning for Asia, where school closures stand out in duration compared with other regions and are especially pronounced in lower-income countries (Figure 2.2, panel 6).
Meanwhile, a population decline after the pandemic is also expected to reduce the labor force and engender scarring in the very long term: Fertility rates have declined during the pandemic—especially in countries with stricter lockdown and economic losses such as Asian emerging market and developing economies— and are unlikely to recover in the medium term. Furceri, Pizzuto, and Yarveisi (forthcoming) provide evidence that major pandemic recessions over the past two decades, even though smaller in scale than COVID-19, have led to persistent declines in fertility rates of about 2.5 percent (Figure 2.2, panel 7).
Policies to Mitigate Scarring
Given the large output losses facing the Asia and Pacific region after the COVID-19 pandemic, an urgent push for structural reform is needed to boost productivity and potential output, improve labor outcomes, and encourage investment. While exact reform priorities will depend on country-specific circumstances, tackling the corporate debt overhang and mitigating human capital losses will be important for a wide range of countries in the region. In addition, faster adoption of digital technologies can mitigate the adverse effects of recessions on productivity and improve resilience in the labor market.
Tackling corporate debt overhang: To reduce corporate leverage and increase the resilience of economies to shocks, policymakers in the region need to adopt improved frameworks to restructure viable firms and liquidate unviable firms to avoid zombification, while promoting the reallocation of capital and labor toward more productive firms. Unwinding the government support extended to firms during the early phase of the pandemic will also be essential to ensure adequate reallocation of resources.
Mitigating human capital losses: A focus on mitigating the effects of school closures on education is needed by assessing learning losses and increasing financing to remediate students’ skills (through additional in-person and teachers’ training, extended school years, and so on). Policies that return people to the labor force (retraining programs and worker reallocation policies, for example) can also help offset labor market scarring after the COVID-19 crisis.
Potential role of digitalization: In addition, policies that promote digitalization are likely to be especially important in a post–COVID-19 world to protect and enhance the education system’s preparedness for future pandemics, boost productivity, and increase firms’ resilience to future shocks.4 Firms and industries harnessing digital technologies can unlock productivity gains, for instance, through automation (Aghion and others 2020; Dabla-Norris and others, forthcoming; Koch, Manuylov, and Smolka 2019) and are better able to connect with distant customers and employees (Bloom and others 2015; Brynjolfsson, Hui, and Liu 2019). Digitalization also improves the ability to work remotely or sell without contact, which are capabilities that have shielded workers and firms from the pandemic’s negative effects (October 2020 Regional Economic Outlook: Asia and Pacific; Abidi, El Herradi, and Sakha 2022; Pierri and Timmer 2020). Companies have adopted new digital technologies rapidly during the current crisis, ranging from teleconferencing software to e-commerce platforms. Capitalizing on such innovations—both technological and organizational—can help alleviate the pandemic’s medium-term scarring effects.
Before the pandemic, progress across various forms of digitalization has been mixed in Asia. While Asian advanced economies and China have seen significant progress in digitalization and are now at the world frontier, digitalization in Asian emerging market and developing economies has lagged (Figure 2.3, panel 1), amplifying the COVID-19 shock’s immediate effect in many of these economies (Figure 2.3, panel 2).5 In Asian advanced economies, the share of the population using the internet has increased significantly over the last two decades, reaching almost 90 percent before the crisis. By contrast, there are still many people without internet access in Asian emerging markets and low-income developing countries. Similarly, Asian advanced economies and China have become an innovation powerhouse, accounting for about 57 percent of all world patents and 58 percent of patents for digital technologies in 2020, but other Asian emerging market and developing economies lag considerably in the field of innovation, contributing only 1 percent and 0.3 percent, respectively (Figure 2.3, panel 3). Moreover, e-commerce revenue has reached more than 2 percent of GDP in Asian advanced economies and China, but it accounts for only about 1 percent of GDP in Asian emerging market and developing economies (Figure 2.3, panel 4).
The pandemic has accelerated digitalization around the world, including in many Asian emerging market and developing economies. For example, e-commerce revenues have increased, with particularly rapid expansion in some emerging markets such as India and Indonesia (Figure 2.3, panel 5). Labor market developments during the pandemic also skewed toward digital sectors. Using novel high-frequency data on job vacancy posts from Indeed, the chapter finds that vacancies in digital sectors fell less than in other sectors after the pandemic and recovered more rapidly, especially in emerging market and developing economies, driven partly by firms’ need to adapt to the new pandemic environment (Figure 2.3, panel 6).6
To quantify the role of digitalization in reducing scarring, the chapter uses several complementary analyses. The first approach, similar to that used for the role of corporate debt, looks at the ability of digitalization to increase the resilience of revenue to typical recessions. The results suggest that firms in more digitalized industries (for instance, the software industry) recorded sales 1.4 percent higher two years after past recessions compared with industries that are less digital (for example, textiles and apparel; Figure 2.4, panel 1).7
The second set of analyses looks specifically at the COVID-19 shock. The results, as expected, suggest that digitalization plays a larger role in the context of the current crisis, with firm revenue after the outbreak being 3.4 percent higher in more digitalized industries. Additional analysis also shows that digitalization supported resilience in employment: hiring rates are higher in industries using more digital skills, and those industries also attract larger net inflows of workers (Figure 2.4, panel 2).8
Conclusion
The analysis presented in the chapter shows that the Asia and Pacific region is expected to suffer significant long-term output losses after the pandemic because of lower investment, productivity growth, and labor force participation. A renewed structural reforms push is essential to mitigate the pandemic’s scarring effects, especially in emerging market and developing economies. Addressing investment scarring stemming from higher corporate debt by promoting orderly deleveraging and mitigating education losses from school closures should be a priority. The analysis in the chapter also shows that digitalization can be a powerful force in mitigating scarring, beyond boosting productivity growth (Dabla-Norris and others, forthcoming), and while Asia has invested rapidly in this area, there is scope for further reforms. Investment to enhance digital connectivity and capabilities should be a priority, especially in low-income developing countries and for disadvantaged groups and regions. Countries with low digitalization outcomes and in which labor markets were affected significantly during the pandemic should invest in training and upskilling their labor forces to enhance resilience to future shocks.
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The importance of tourism and stringency in explaining output losses is consistent with previous literature—for example, the October 2020 Regional Economic Outlook: Asia and Pacific; the April 2021 World Economic Outlook, Chapter 2; Furceri and others (2021); and Goretti and others (2021). A cross-sectional regression using the latest data on expected output losses for 130 countries also reveals stringency of containment measures and tourism to GDP as significant contributors to scarring, while fiscal support partly mitigates output losses.
The decline in corporate leverage in Australia and New Zealand between 2019 and 2021 potentially reflects lower debt levels for commodity producers that have benefited from high commodity prices.
The detailed quarterly balance sheet data on firm leverage and investment allow for better identification of the impact of recessions. The analysis uses Jordà’s (2005) local projection method on a firm-level database for 75 countries, over the period from the first quarter of 2001 to the fourth quarter of 2020, to estimate the scarring effects of recessions and how they are amplified by the level of debt. In a first step, it estimates the average (unconditional) effect of recessions on firms’ investment, and in the second step, it uses a difference-in-differences specification to analyze how this investment response after a recession varies for high-debt firms versus low-debt firms. See Estefania-Flores and others (2022) for details.
Digitalization is a broad concept, including use of digital technologies, data, and interconnection that results in new activities or changes to existing activities (OECD 2019). Reflecting the breadth of this concept, there is not yet a single generally accepted measure of digitalization (OECD 2021). We therefore draw on a range of measures, as described in the following and in Copestake, Estefania-Flores, and Furceri, forthcoming.
For example, Furceri and others (2021) find that the effect of similar increases in lockdown stringency measures have been much larger in emerging market and developing economies than in advanced economies.
The data set provides daily counts of job posts for 64 occupational categories and 35 countries between January 2018 and July 2022.
The analysis follows a similar approach as Estefania-Flores and others (forthcoming) and uses a difference-in-differences specification to analyze how the firms’ revenue response varies with the level of sectoral digitalization. The results are consistent across a range of measures of digitalization, including (1) that of Calvino and others (2018), who combine information and communications technology input shares, robots per employee, and online sales shares; (2) information technology goods and services input shares from national input-output tables; and (3) firm-level intangibles shares. See Cope-stake, Estefania-Flores, and Furceri (forthcoming) for details.
The analysis of hiring rates and worker transitions again adopts a difference-in-differences approach, in this case using monthly data from LinkedIn covering 20 broad industries across 40 countries between 2016 and 2022. Hiring rates are calculated using the share of LinkedIn members adding a new employer to their profile in the same month that the job begins, and digital skills usage is calculated using the proportion of such skills listed by users within a particular country-industry pair.
