Russian factory workers
Few firms or businesses in Europe and Central Asia escaped the economic impacts of the COVID-19 pandemic. Many experienced decreased sales, output and productivity, especially at the onset of the crisis, due to sudden supply and demand shocks caused by the necessary lockdowns and movement restrictions. Smaller firms were among those worst impacted.
These shocks were compounded by widespread uncertainty among businesses, alongside concerns about the risks of increasing financial sector distress limiting access to credit. It was critical, therefore, for governments to move rapidly with support measures for businesses and firms, with a focus on protecting jobs and livelihoods.
Global economic activity is recovering and output in Europe and Central Asia is expected to bounce back in 2021. While this overall growth is welcomed news, many challenges remain. What can we learn from the crisis that will help countries boost their business environments and achieve a strong and resilient recovery?
Let’s look at how the crisis affected firms’ growth, employment and technological adaptation. All three are essential to firm survival. Firm-level survey data for private sector companies in 23 countries in the region, collected in several rounds since the beginning of the crisis, reveals that the pandemic had a profound and varied impact on firms.
On average, in the first survey round conducted between May and November 2020, firms in the region reported a drop in monthly sales of 24 percent and a 10 percent decline in the number of full-time employees compared to the previous year.
By round 2, conducted between November 2020 and May 2021, one in four firms reported that it anticipated falling into arrears on outstanding liabilities in the next six months. Smaller and younger firms were hit harder by the crisis and had not yet seen their sales improve since the initial drop. Female-run firms were not affected worse than male-run firms initially, but their recovery is taking longer.
Although the crisis was devastating for many firms, it also led to a reallocation from many less productive firms to more productive ones. Across Europe and Central Asia, this is especially evident in countries with more competitive markets.
Indeed, firms with high labor productivity prior to the crisis experienced significantly smaller drops in sales and employment than those with low pre-crisis labor productivity. More productive firms were also more likely to adapt to the crisis by increasing online activity and remote work.
Importantly, in countries with more competitive markets and stronger policies that protect competition, this reallocation towards more productive firms was even greater. Reallocation of economic activity toward more productive firms over the long-term will likely depend on whether more productive firms grow and less productive firms ultimately exit the market.
What role does competition play?
Competition is associated with dynamism, incentivizing firms to innovate, forcing more efficient firms to enter the market and grow, while facilitating the exit of less efficient ones. Both perception-based and regulatory indicators suggest that most countries in Europe and Central Asia could improve both their institutional framework and enforcement of laws for a strong competition environment. This is especially true for countries in Central Asia and the South Caucasus.
The pandemic has also heightened concerns about limited competition and its potential consequences for economic recovery in the region. For example, if smaller firms find it more difficult to adopt new technologies or business models, and are less likely to receive government support, they are more likely to exit, leading to greater concentration of large firms in the market. This would further limit competition, just when it is most needed to promote recovery.
Many governments across Europe and Central Asia implemented broad policy support measures to promptly address the initial economic fall-out from the pandemic. The reach of government support measures varied widely across countries, but on average, half of the firms surveyed reported receiving some government support in response to the crisis.
Overall, government support was more likely to go to less productive firms. Larger firms were more likely than smaller firms to receive support in the form of payment deferrals and fiscal relief. And support measures were given to firms regardless of their level of innovation prior to the crisis.
Broad support measures implemented at the beginning of the crisis aimed to protect the most vulnerable. This was a vital step for governments to take. Over the long-term, however, if less productive firms stay in the market with the help of government support, they can stifle innovation and growth, hampering job creation and recovery.
As countries look to a post-pandemic future, it will be important for policy makers to phase out indiscriminate support measures as soon as appropriate, and focus instead on fostering a competitive business environment for firms, while protecting households in need. This is key to ensuring a strong, inclusive, sustainable recovery which benefits everyone.
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Download the report: Fall 2021 Europe and Central Asia Economic Update – Competition and Firm Recovery Post-COVID-19
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