August 2020 · Number 9A The Impact of COVID-19 on Formal Firms: Evidence from Albania Pierre Bachas, Anne Brockmeyer, Camille Semelet, Christoph Ungerer1 S UMMARY in 2020 would only collect 65% of its baseline. In addition, firms accumulate losses equivalent to 1.6% of GDP, suggesting that firms This note uses administrative tax data on firms to measure the will need to substantially increase borrowing to survive. Firms would direct impact of the lockdown on firms’ profitability, employment cut 3.9% of total yearly payroll - wage subsidies can save a substan- and exit rates. It separates the economy in three sectors, which face tial share of payroll in the medium-impact sector, but will not be able different size shocks and considers two lockdown scenarios: one to save employment in the high-impact sector (tourism, transport, lasting three months and one lasting five months. The five-month personal services), where firms can’t pay their fixed costs. scenario is equivalent to a three-month initial lockdown and a later re- introduction of a two-month lockdown, or a longer partial lockdown. This note faces important limitations: (i) it does not include the The simulations estimate losses to corporate income tax revenue, indirect impacts of the shocks which operate through firms’ trade increases in firms’ debt levels, cuts in payroll and their mitigation linkages, (ii) it only models a demand shock and as such firms have through wage subsidies, and aggregate output losses from firms’ exit. no issues obtaining inputs (materials, labor), (iii) Firms do not adapt to the crisis (for example by changing products, selling online etc.). Overall, the impact on the economy is severe, with large falls Given these limitations, the numbers in this report should be consid- in tax revenue, increases in debt and loss of employment. Under a ered as plausible lower bounds arising from direct effects, in partial three-month lockdown, we estimate that 61% of firms remain prof- equilibrium. Dynamic general equilibrium models of the economy, itable and that more than 86% of firms in the highly-impacted sectors with linkages across sectors and firms, are needed to gauge longer register losses. The corporate income tax revenue loss is severe and term effects. 1 World Bank: pbachas@worldbank.org, abrockmeyer@worldbank.org, csemelet@worldbank.org, cungerer@worldbank.org. The findings and conclusions are those of the authors; they do not represent the views of the World Bank, its member countries or the countries mentioned in this study. We are grateful to the Albanian Ministry of Finance and Revenue Authority for providing the data used in this study. We thankfully acknowledge funding by the World Bank through the Knowledge of Change Trust Fund and the Fiscal Policy and Sustainable Growth Unit. 1 L OCKDOWN S IMULATIONS AND C ATEGORIZATION fixed costs. Finally, we assume that credit constraints prevent bor- OF S ECTORS BY I MPACT rowing beyond existing loans used to cover predictable losses (i.e. The COVID19 (coronavirus) pandemic and associated con- losses unrelated to the shock). tainment measures are expected to cause far-reaching damage to economies around the world. Firms are suffering from reduced de- We classify sectors into three impact categories - high, mand due to movement restrictions, from reduced labor supply and medium and low – depending on their expected loss in revenue from constraints to sourcing material inputs. The breakup of oth- during the shutdown, displayed in Table 1. This classification is erwise healthy businesses in response to a temporary shock implies based on a country-specific ad hoc assessment by the Ministry of large social costs. Governments are therefore intent on designing Finance. In the high-impact category are sectors which can’t operate emergency policies to keep businesses afloat. at all during the lockdown and lose 100% of their revenue during that period. These include tourism, transportation, non-essential re- We present simulations using firm-level tax records from Al- tail and entertainment. In the medium impact categories are sectors bania, which vary the duration of the lockdown and the relative which operate at half capacity and lose 50% of their revenue. These impact across sectors. In these simulated scenarios, demand shocks include manufacturing and education. Finally, the low impact sector induce a loss in revenue which triggers a cut in profitability and pos- only loses 20% of its monthly revenue, in sectors such as essential sibly cuts in employment or even firm closure. We compare these retail, health, construction and agriculture. Naturally there is still a simulations to a baseline (pre-COVID) situation, which corresponds fair degree of heterogeneity of exposure within the categories, with to the last year of available administrative data. Our analysis relies some subsectors experiencing increased revenue. Table 2 shows the on a few simple assumptions about the structure of firms’ revenue number of firms and economic weight of each of the three impact and costs: we assume that firms aim to weather the shock such that sectors: the high-impact sector contains 13% of the firms and 6% of they can scale their production capacity back up swiftly at the end of the wage bill, the medium impact sector contains 28% of the firms the lockdown. In this stylized world, firms can reduce their material and 37% of the wage bill, and the low-impact sector the remaining costs proportionally to the drop-in demand, are reluctant to reduce 59% of the firms and 57% of the wage bill. their labor costs as re-contracting is costly and cannot adjust their Table 1: Sector Categories and Shocks Sectors Expected Monthly Categories (e.g., detailed list of sectors in Appendix Table 5) Revenue Loss Accommodation and Food Service Activities, Transportation and Non-essential retail, and High Impact other highly affected sectors 100% Manufacturing Activities, Education and other moderately Medium Impact affected sectors 50% Essential Retail, Human Health and Social Work activities and other mildly Low Impact affected sectors 20% Table 2: Statistics for High, Medium and Low Impact Sectors Aggregates Averages Wage Avg. size Avg. Labor Material Fixed Number Share Revenue Categories of firms of firms share bill (LCU, in Profit costs (% costs (% costs (% share millions) margin Total cost) Total cost) Total cost) High impact 2440 13% 5% 6% 51 10% 26% 53% 21% Medium impact 5180 28% 31% 37% 135 12% 26% 45% 29% Low impact 11165 59% 64% 57% 130 12% 23% 57% 19% E FFECT ON F IRMS ’ P ROFITABILITY in Figure 1, and show that in the high and medium impact sectors the vast majority of firms becomes unprofitable even under the three- In this section, we ask what share of firms would need gov- month lockdown scenario. In our simulations, as we use annual data, ernment support to “stay afloat” under a three-month and a five- the five-month lockdown scenario could represent either a contin- month lockdown scenario. Assuming credit constraints, a rough ued lockdown lasting five months or a shorter lockdown (e.g. three indication for firms’ ability to stay afloat is a non-negative profit rate. months) combined with the re-imposition of a lockdown later in the We start by simulating scenarios where firms lose a share of their year (e.g. for two months) or a partial continuation of lockdown (e.g. revenue, while all costs remain constant. The results are displayed a 50% lockdown for four months). 2 Figure 1: Firm Profitability Under a Shock to Revenue, No Adjustment to Costs (a) 100% Revenue loss (b) 50% Revenue loss (c) 20% Revenue loss Note: These figures show the distribution of profitability, at baseline, and assuming that firms face a loss in revenue corresponding to either three or five months of loss in yearly revenue. They show the distributions holding all costs constant. In addition to a pure revenue shock, we simulate a more re- inputs than the high impact sector. On aggregate, 61% (50%) of all alistic scenario where firms adjust their material costs propor- firms remain profitable under a three-month (five-month) lockdown. tionally to their revenue loss. The results are displayed in Figure 2: We also observe that the distribution becomes slightly multi-modal 86.2% of firms in the high-impact sector are profitable at baseline, a for high impact firms: while firms using mainly material inputs and number which drops to 26.3% for the three-month lockdown scenario little labor or capital inputs can adjust to some extent and limit their and to 13.7% under a five-month lockdown. The impact is less se- losses, firms with a small share of material inputs in total cost have vere in the medium and low impact sectors, since the shock they face little margin to adjust and suffer much larger losses. is less severe and since these sectors rely more heavily on material Figure 2: Firm Profitability Under a Shock to Revenue, Material Costs Adjust in Proportion (a) 100% Revenue loss (b) 50% Revenue loss (c) 20% Revenue loss E FFECT ON E MPLOYMENT AND S IMULATIONS OF corresponds to firms which have to cut their wage bill proportion- WAGE S UBSIDIES ally to the shock in an attempt to stay afloat. In the middle of the distribution, a share of firms reduces their wage bill somewhat (but In this section, we study by how much employers would need less than proportionally to the shock) and achieves zero profit (or to slash their yearly wage bill in the absence of government sup- retains to pre-shock projected losses): providing even modest wage port. We continue to assume that material inputs adjust first, and subsidies to these firms has the potential to save jobs. On aggre- that firms only cut their wage bill if they are still unprofitable after gate, weighting by firms’ yearly wage bill, this would lead to a cut the material inputs adjustment. Figure 3 shows the resulting distri- in payroll of 3.9% (resp. 8.5%) of the formal economy’s total yearly butions of the reduction in the yearly wage bill for a three or five wage bill in the three-month lockdown (resp. five-month). The pay- month lockdown scenario. The figure is bi-modal: the first spike cor- roll loss is of course concentrated in the high-impact sectors which responds to firms which are sufficiently profitable at baseline: they would cut 15.9% (resp. 33.2%) of payroll under the three-month absorb the shock and keep paying their workers. The second spike lockdown (resp. five-month). 3 Figure 3: Wage Bill Reduction from a Revenue Shock, Material Costs Adjust Proportionally (a) 100% Revenue loss (b) 50% Revenue loss (c) 20% Revenue loss Key Fiscal Policy Responses to COVID-19, as of May 21, 2020:a 1. Package adopted on March 19th (1.4% of GDP): • Additional funding for health sector • Support of small businesses/self-employed forced to close activities by paying them minimum salaries • Defense spending reallocated toward humanitarian relief for the most vulnerable • Sovereign guarantee fund for companies to access overdrafts in the banking system to pay wages for their employees for up to three months with an interest rate capped 2. Package adopted on April 15th (1.3% of GDP): • Fund to pay for a one-off transfer to employees of small businesses affected by the pandemic not covered in the first package, employees of large businesses laid off, and employees in the tourism sector • Sovereign guarantee to provide loans for working capital for all private companies that were tax-compliant and solvent before the pandemic • Tax deferral measures allowing certain companies to defer payment of profit tax until after September. Tourism, active processing and call centers, and small businesses can defer payments of profit tax to next year. a Source and more details can be found on the IMF Policy Reponses to COVID-19 page WAGE S UBSIDY S IZE AND E MPLOYMENT E FFECTS numbers mentioned above. As the wage subsidy increases the loss in payroll decreases, as some firms now return to zero profits (or to To counteract these payroll losses and destruction of jobs, the their baseline losses). The impact on payroll loss is however very government might consider offering wage subsidies to firms, in different across the three impact sectors: On the one hand, for the order to protect formal employment. Figure 4 shows each sector’s high impact sectors (Figure 3a), the loss in revenue is too severe to aggregate payroll losses when varying the size of the wage subsidy, be compensated by wage subsidies and these firms are forced to cut measured as the share of firms’ payroll paid by the government. In employment, even for large wage subsidies. the case of a zero-wage subsidy the loss in payroll corresponds to the 4 Figure 4: Aggregate Sector Loss in Payroll as a function of the Size of the Wage Subsidy (a) 100% Revenue loss (b) 50% Revenue loss (c) 20% Revenue loss Note: These figures show to what extent a government wage subsidy for the retained labor force can absorb the aggregate loss in payroll, if the lockdown lasts three or five months. Firms readjust their decision after receiving a wage subsidy: they first adjust their material costs, and then their wage bill. We still assumed that firms keep paying wages as long as they remain profitable. To understand this, note that we assume that these firms still have to pay their fixed costs (e.g. rent) and a reduction in labor costs is Figure 5 shows that the wage subsidies will push an additional not sufficient to counteract the revenue loss. On the other hand, wage 40 percentage points of the high impact sector firms into non-loss subsidies can save payroll for the low, and especially the medium- making territory. In the five month lockdown scenario, the share of impact sector: in the latter sector, a 60% wage subsidy over the lock- high impact firms which are not loss making would jump from under down period would roughly halve the sector’s payroll loss. On aggre- 17% without the wage subsidies, to almost 60% with the subsidies. gate, applying a 50% wage subsidy across all sectors would reduce the yearly payroll loss from 3.9% to 2.0% (three-month lockdown) or Figure 5: Firms’ Profitability with and without the Government from 8.5% to 6.3% (five-month lockdown). It would take a substan- Wage Subsidies tial subsidy to save more payrolls: even with a 90% wage subsidy the loss in yearly payroll would be reduced only to 1.5% (three-month lockdown) or to 3.5% (five-month lockdown). WAGE S UBSIDIES AS I MPLEMENTED AND I MPACTS ON P ROFITABILITY AND E MPLOYMENT The Government of Albania has adopted a large multi-faced package of measures to counter the impact of COVID19 on for- mal firms and offers wage subsidies for key sectors. Among other measures (see Key Fiscal Policy Responses to COVID-19), firms which have to shut down (i.e. high impact sector firms) benefit from a subsidy of 100% of the gross minimum wage for all employees. We do not observe the number of workers of each firm, but its total payroll has been imputed by using the cost structure of other coun- tries: to make progress, we assume that each firm pays its workers the average wage in the economy.2 We continue to assume that firms Note: This figure show the share of non-loss making firms after a 3 or 5 month lockdown, adjust their costs in reaction to the subsidy as above. We set the subsidy to 100% of the gross minimum wage,3 per month and per with or without the wage subsidy implemented by the Government of Albania. Loss making firms include firms with zero profits. worker, for the high impact sectors, which roughly corresponds to a 50% subsidy of the full payroll. F IRMS ’ E XIT R ATES I NDUCED BY THE R EVENUE As previously shown in figure 4, the subsidies offered in prac- S HOCK tice might not be enough to curtail short term payroll losses Here we predict the increase in firms’ exit under the differ- significantly in the high impact sector, although they have more ent lockdown scenarios. We use the panel dimension of the data to of an effect on the medium impact sector. However, they might be measure the excess exit rate in pre-crisis years separately for nega- able to bring a non-negligible set of firms back to non-loss making tive and positive profit firms (and in each of the three impact sectors). territory, which could allow them to survive the lockdown and restart Figure 6 (a) shows these exit rates in regular times: on average 12% operations thereafter. of firms exit in any given year; however firms which had losses in 2 We use the Average labour costs per employee in full time units by economic activity provided by the Albanian Statistical Institute. 3 In 2019, the gross minimum wage equals EUR210.66 (Lek 26,000). 5 the previous year have an exit rate which is at least 20% higher than show the results for the three and five-month lockdown scenario in 6 firms which had positive profits. In our previous analysis, we esti- (b): under a three (five)-month lockdown scenario, firms’ exits from mated the share of firms which have negative profits due to the crisis, the formal economy increase by 145% (218%). This loss of firms for each impact sector. We thus combine these results to measure is of course particularly acute for the high impact sector where the the percentage increase in exits induced by the crisis, by multiplying percentage increase in firms’ exits is 392% (480%) compared to the the share of newly loss-making firms with their excess exit rate. We average pre-crisis year. Figure 6: Firms’ Exit Rate (a) Pre-Crisis Average Exit Rate (b) Crisis Induced Exits Note: Panel (a) shows the average exit probability for all firms, and then for loss-making and profit-making firms, using panel data before the crisis. Panel (b) shows the percentage increase of firms’ exit induced by a 3 or 5 month output loss, compared to baseline levels. AGGREGATE N UMBERS AND I MPACTS ON THE the three-month shock [five-month shock], suggesting that firms will E CONOMY need to substantially increase borrowing. Payroll losses are also sub- stantial, ranging between 3.9% and 8.5% of the annual wage bill - The impact on the overall economy is severe, with large falls wage subsidies can safeguard some employment, especially in the in tax revenue, increases in debt and loss of employment. Table medium-impact sectors: a 50% wage subsidy would reduce the pay- 3 summarizes the key numbers for the three and five-month lock- roll losses from 3.9 to 12.0% (8.5% to 6.3%) in the three (five) month down scenarios and the aggregate impact on the economy. 61% or lockdown scenario. Increases in firm exit are relatively small, mean- less of firms remain profitable after the shock, and almost all firms ing that associated output and payroll losses are also small, but this is in the highly impacted sectors register losses. The Corporate Income likely an under-estimate: Our panel data features only a smaller num- Tax revenue loss is severe, reaching 34% overall in the three-month ber of firms that experience large revenue losses and hence allow us shock scenario and 49% in the five-month shock scenario. In the to estimate the effect, presumably because most such firms exit the high-impact sectors, almost all CIT revenue is lost. This is because, panel. Our estimates mean that the size of government rescue pack- despite the temporary nature of the shock, the shock generates large ages for firms and workers needs to be large, and the budget support losses which are counted against the profits made during the remain- from donors to lower-income countries even larger, to compensate der of the year. The absolute increase in losses is 1.6% (3.8%) with for the massive loss in tax revenue. 6 Table 3: Aggregate Impacts by Lockdown Duration and by Impact sectors High Impact Medium Impact Low Impact All Sectors 3 5 3 5 3 5 3 5 months months months months months months months months Share of firms 1 profitable at baseline 86.2% 85.8% 87.4% 86.8% Share of firms still 2 profitable (material adj.) 26.3% 13.7% 48.0% 32.4% 74.9% 65.3% 61.2% 49.5% CIT revenue loss 3 relative to baseline (%) 66.4% 84.8% 45.8% 61.8% 22.0% 34.1% 34.4% 48.5% Absolute losses 4 increase (% GDP) 0.4% 0.9% 0.8% 2.1% 0.3% 0.7% 1.6% 3.8% No wage subsidy 15.9% 33.2% 5.8% 13.2% 1.4% 2.9% 3.9% 8.5% 50% wage 5 Payroll Loss subsidy 15.0% 31.9% 2.7% 11.4% 0.2% 0.4% 2.0% 6.3% 90% wage subsidy 14.1% 30.5% 1.9% 4.6% 0.0% 0.0% 1.5% 3.5% Percentage increase in 6 exit relative to baseline 392.2% 480.3% 149.5% 225.0% 83.7% 150.7% 145.3% 218.0% Permanent output loss 7 from firm exit (% GDP) 0.2% 0.3% 0.7% 1.1% 0.4% 0.8% 1.4% 2.1% Permanent payroll loss 8 from firm exit (% GDP) 1.4% 1.7% 4.0% 6.1% 3.1% 5.7% 8.5% 13.4% 7 Table 4: Absolute losses, in Million Lek, by Lockdown Duration and by Impact sectors4 High Impact Medium Impact Low Impact All Sectors 3 5 3 5 3 5 3 5 months months months months months months months months CIT revenue loss 1,163 1,485 5,487 7,406 3,402 5,270 10,052 14,161 Additional losses 6,299 13,520 12,244 32,001 5,083 11,138 23,626 56,659 No wage subsidy 3,271 6,824 7,445 16,890 2,732 5,855 13,447 29,569 Payroll 50% wage Loss subsidy 3,088 6,560 3,439 14,564 333 819 6,861 21,944 90% wage subsidy 2,896 6,269 2,433 5,873 1 1 5,330 12,144 Permanent output loss (Billion Lek) 331 405 1,085 1,633 634 1,142 2,050 3,180 Permanent payroll loss (Billion Lek) 2,037 2,494 6,079 9,148 4,733 8,525 12,849 20,167 4 Nominal figures are adjusted for 2020 inflation (forecast inflation rate is 2.39% for 2019-2020, according to The World Economic Outlook (WEO)). 8 A PPENDIX Table 5: Sectors and Impact Categories SECTORS (ISIC Rev 4 code) High - Medium - Low Impact A AGRICULTURE, FORESTRY AND Low Impact FISHING B MINING AND QUARRYING Low Impact C MANUFACTURING Low Impact Medium Impact Food products; Beverages; To- Textiles; Wearing apparel; Leather bacco products; Basic pharma- and related products; Wood and of ceutical products and pharma- products of wood and cork, except ceutical preparations furniture; manufacture of articles of straw and plaiting materials; Pa- per and paper products; Printing and reproduction of recorded me- dia; Coke and refined petroleum products; Chemicals and chemi- cal products; Rubber and plas- tic products; Other non-metallic mineral products; Basic metals; Fabricated metal products, except machinery and equipment; Com- puter, electronic and optical prod- ucts; Electrical equipment; Man- ufacture of machinery and equip- ment n.e.c.; Motor vehicles, trailers and semi-trailers; Other transport equipment; Furniture; Other man- ufacturing; Repair and installation of machinery and equipment D ELECTRICITY, GAS, STEAM AND Medium Impact AIR CONDITIONING SUPPLY E WATER SUPPLY; SEWERAGE, Medium Impact WASTE MANAGEMENT AND REME- DIATION ACTIVITIES F CONSTRUCTION Medium Impact 9 G WHOLESALE AND RETAIL TRADE High Impact Low Impact other than food, pharamacies, gas sta- tions Automobile Dealers; Other Mo- Remaining sub-categories tor Vehicle Dealers; Furni- ture Stores; Home Furnishings Stores; Clothing Stores; Shoe Stores; Jewelry, Luggage, and Leather Goods Stores; Sport- ing Goods, Hobby, and Mu- sical Instrument Stores; Book Stores and News Dealers; De- partment Stores; Florists; Of- fice Supplies, Stationery, and Gift Stores; Other Miscella- neous Store Retailers; Con- sumer Goods Rental; General Rental Centers; Apparel, Piece Goods, and Notions Merchant Wholesalers; Automotive Parts, Accessories, and Tire Stores; Direct Selling Establishments H TRANSPORTATION AND STOR- High Impact Medium Impact AGE Scheduled Air Transportation; Nonscheduled Air Transporta- tion; Taxi and Limousine Ser- vice; School and Employee Bus Transportation; Other Transit and Ground Passenger Trans- portation; Support Activities for Air Transportation; Support Ac- tivities for Water Transporta- tion; Traveler Accommodation I ACCOMMODATION AND FOOD High Impact Medium Impact SERVICE ACTIVITIES Special Food Services; Drink- Remaining sub-categories ing Places (Alcoholic Bever- ages); Restaurants and Other Eating Places 10 J INFORMATION AND COMMUNI- Low Impact CATION K FINANCIAL AND INSURANCE AC- Medium Impact TIVITIES L REAL ESTATE ACTIVITIES Medium Impact M PROFESSIONAL, SCIENTIFIC AND Low Impact TECHNICAL ACTIVITIES N ADMINISTRATIVE AND SUPPORT Low Impact SERVICE ACTIVITIES O PUBLIC ADMINISTRATION AND Low Impact DEFENCE; COMPULSORY SOCIAL SECURITY P EDUCATION Medium Impact Q HUMAN HEALTH AND SOCIAL Low Impact WORK ACTIVITIES R ARTS, ENTERTAINMENT AND High Impact Medium Impact RECREATION Performing Arts Companies; Remaining sub-categories Spectator Sports; Independent Artists, Writers, and Perform- ers; Amusement Parks and Arcades; Gambling Industries; Other Amusement and Recre- ation Industries S OTHER SERVICE ACTIVITIES High Impact Medium Impact Offices of Dentists; Personal Remaining sub-categories Care Services; Other Personal Services 11 C ALCULATION DETAILS FOR TABLE 3 sum of all firms’ losses after lockdown minus (2) absolute value of the sum of all firms’ losses at baseline, divided by (3) Each figure is calculated for a specific Impact category (High, GDP (current LCU of the same year), expressed as percentage. Medium, Low impact and All sectors) and for a specific lockdown scenario (three and five months): 5. Payroll Loss, at different wage subsidy rate: (1) sum of all firms’ new labor costs under lockdown, divided by (2) the sum 1. Share of firms profitable at baseline: (1) number of firms with of all firms’ labor costs at baseline, expressed as percentage. positive profit margin before output shock, divided by (2) total number of firms, expressed as percentage. 6. Percentage increase in exit rate relative to baseline: (1) exit rate 2. Share of firms still profitable (material adj.): (1) number of of firms after lockdown minus (2) exit rate of firms at baseline, firms with positive profit margin, after material costs adjust- divided by (2) and expressed as percentage. ment proportional to the shock, divided by (2) total number of 7. Permanent output loss from firm exit (% GDP): (1) additional firms, expressed as percentage. exit rate relative to baseline multiplied by (2) the sum of all 3. CIT revenue loss relative to baseline: (1) sum of all firms’ prof- firms’ turnover at baseline, divided by (3) GDP (current LCU its at baseline multiplied by the corporate income tax rate mi- of the same year), expressed as percentage. nus (2) sum of all firms’ profits after lockdown multiplied by the corporate income tax rate, divided by (1) and expressed as 8. Permanent payroll loss from firm exit (% GDP): (1) additional percentage. exit rate relative to baseline multiplied by (2) the sum of all firms’ labor costs at baseline, divided by (3) GDP (current 4. Absolute losses increase (% GDP): (1) absolute value of the LCU of the same year), expressed as percentage. 12