The human cost of the COVID-19 pandemic is incalculable. Most important is the loss felt by communities that experience the worst that the disease can bring. Many are feeling the stress and isolation resulting from long periods of social distancing. There is, of course, an economic cost as well and, at the individual level, the worst of these include losing one's livelihood. Job losses also impose broader costs on society. As household incomes fall, consumer spending and tax revenues suffer. Borrowers are less likely to repay their debts. Job seekers lose skills and become discouraged.

Jobs are at the core of the current economic crisis. Measures designed to limit viral spread are striking at the heart of the engine of job creation across Asia-Pacific--the service sector. The unfortunate truth about jobs in almost every economy in the world is that they are easily lost but hard to win back. The more jobs that are lost today, the slower will be the recovery. Surging unemployment would not only be terrible news for those out of work, it would have major credit implications across sectors.

Policymakers know this, hence the remarkable efforts to encourage firms to keep workers on the payroll. Wage subsidy programs are being rolled out from Hong Kong to New Zealand and payroll taxes are being slashed elsewhere. These policies should help limit the damage to the labor market. They are large and well-targeted. However, their cost-benefits deteriorate over time, questioning how long they can help.

Why Jobs Are So Vulnerable To COVID-19

The COVID-19 shock has hit the service sector hard. Service sector activities often require human-to-human contact while mitigation policies aim at social distancing. The clash of these two is obvious. Any activity that cannot be done online or by phone will feel the full force of these policies. At the same time, the service sector fuels job growth. This is as true in China as it is in Australia and Japan.

The power of the service sector jobs engine is shown by its contribution to total employment growth over the past two decades (see chart 1). Across the region, especially in China and other emerging markets, agricultural jobs have disappeared but contrary to popular wisdom, these workers did not stream mainly to factories. Instead, they mostly started work in hotels, restaurants, and shopping malls. The hospitality sector's contribution to China's overall employment growth has been five times as large as that for industry over the last two decades.

Chart 1

The service sector has become the most important employer across the region (see chart 2). Out of every 100 workers in Asia-Pacific, 55 on average work in services, of which 22 work in wholesale and retail trade or hospitality. This compares to just 14 workers in the entire industrial sector.

Chart 2

Small and midsized enterprises (SMEs) have created many of these new service sector jobs. Firms with less than 250 employees account for almost 70% of all jobs in Australia, Japan, Korea, and New Zealand, close to the average for all OECD economies. [1] The share in emerging markets is estimated to be lower but still high at about 50%. [2] SME employment is concentrated in the very sectors most disrupted by virus mitigation policies, especially retail trade, hospitality, and other "market services" that involve face-to-face activity.

SMEs usually have fewer resources to draw on to weather an economic sudden stop. Access to finance is a perennial challenge for smaller firms, and is likely to worsen when lenders are more uncertain about the outlook and cut back their exposures. As revenues collapse, to stay alive, these firms will be forced to cut whatever expenses they can. In many cases, their largest expense will be the wage bill.

Large Recessions Lead To Big Rises In Unemployment

Recessions almost always cause unemployment to rise. Still, there are big differences across countries, reflecting varying regulations and customs. A larger number of part-time jobs could mean that hours worked changes more than the number of jobs. The grey economy can also help absorb jobs, but this is often not counted in official data.

We estimated how a hit to growth of about 7.5 percentage points (ppt)--close to what we forecast for the COVID-19 impact in 2020, before the effect of policy support--could affect unemployment rates across Australia, Japan, Korea, New Zealand, and Thailand. Our estimates come from a statistical model that can take account of the interactions between growth and unemployment over time. [3] We chose these economies because they provide a long history of detailed labor market data. We kept it simple by assuming that each economy suffered two consecutive quarters of "shocks" to growth of -20ppt and -10ppt, respectively. These shocks are close to what many economists now think is the cost of two to three months of stringent social-distancing measures. These shocks are annualized so the full-year impact is reduced growth of about 7.5 percentage points (before taking into account all of the feedbacks in the model). To keep it simple, we used the same shocks across economies.

The results show large growth shocks cause unemployment rates to rise and peak about four quarters later (see chart 3). The rise in unemployment ranged from about 2ppt in Japan to above 4ppt in Korea. These results are statistically significant. For Thailand, the unemployment rate hardly moved at all. While there may be reasons for this--for example, migrants returning to the countryside without registering as unemployed--there may also be problems with the underlying data.

Chart 3

Models use history as a guide but, as we have argued, this is a unique shock--the speed at which jobs are being lost in the U.S. is testament to that. Given the way the services sector is being hit by social-distancing measures, it's plausible that, for every percentage point fall in growth in Asia-Pacific, the rise in unemployment could be larger now than in previous cycles.

Jobs Are Easily Lost But Hard To Win Back

Eyeballing an unemployment rate chart from almost any economy on the planet reveals an uncomfortable truth: jobs are easily lost but hard to win back. Take for example the unemployment rate in Australia (see chart 4). The pattern is one of sudden sharp upward spikes (shaded) followed by more gradual downward drifts. We have added a long-term trend for the unemployment rate because structural changes in labor markets can cause this to rise or fall over long periods.

Chart 4

Economists have offered intuitive explanations for this unfortunate asymmetry. Once unemployed, searching for a new job, even when the recovery is in place, can be difficult and costly. Firms and workers need to find each other--the so-called "matching problem." There is of course no matching problem when firing workers. [4]

Another problem is that insiders, workers who retained their jobs during the recession, have greater bargaining power during the recovery. Because these workers already have the skills and knowledge to do the job, they can ask for higher wages as activity picks up, which makes hiring additional workers at the new higher wage less attractive. [5]

An even worse problem is that unemployment can remain permanently higher after a sustained period of low demand--economists call this "hysteresis". One explanation is that the longer a person is unemployed, the more that his or her skills and knowledge atrophy, making it harder to find work at a wage they find acceptable. [6] A long period of unemployment can also erode the motivation to keep searching. [7]

This "easily lost, hard to win back" problem is evident in Asia-Pacific. Chart 5 shows the duration of up (busts) and down (recovery) cycles in unemployment rates since 1980 (where data are available). In every economy except Singapore, busts happen much more quickly than recoveries. In fact, busts tend to last about six to eight quarters while recoveries take about eight to 10 quarters (or two to three years). This gap is especially high in Australia, Hong Kong, and Korea.

Chart 5

The good news is that there is little difference between the gains and losses in the unemployment rate during these cycles (see chart 6). In other words, while it does take time, lost jobs are eventually won back. During busts and recoveries, the unemployment rate rises and falls, on average, by about 1.5ppt. (This is some way below our impact estimates in chart 3.) The largest rises are seen in Australia, Hong, and New Zealand. Of course, the bigger the growth shock and the more it is centered on labor-intensive sectors, the larger the unemployment.

Chart 6

Hours Not Just Jobs May Be A Casualty

Workers may suffer from a cut in their hours and, as a result, their wages even if they do hang onto their jobs. Changes in hours per worker can be at least as important as the number of jobs when explaining the cyclical ups and downs in some economies. [8] The rising share of part-time and casual employment could mean hours change more and jobs less than in previous cycles. For nine economies across Asia-Pacific where we have data, part-time jobs now account for almost 25% of total employment, with the highest shares in Australia, Japan, and Indonesia at about 32%.

Hours for part-time workers are typically, but not always, more volatile. Actual hours worked by the average part-time worker are much more variable than for their full-time peers in Australia and Korea (see chart 7). One reason is that part-time work often provides the least regulatory protection of working conditions. [9] A second reason is that employers increasingly rely on part-time workers to provide them with more flexibility. The extreme example is the zero-hours contract where the employer offers no minimum hours and the employee is "on call". In a recession, hours can easily be set to zero.

Chart 7

Policies Can Cap The Rise In Unemployment…

Knowing that jobs are easily lost and hard to win back, policymakers are trying to forestall such losses. The tactics differ but the strategy and aims are similar across countries--encourage employers to keep workers on the payroll and keep paying them close to their normal wage.

Australia, Hong Kong, New Zealand, and Singapore have taken the most direct approach of directly subsidizing wages up to a certain amount and for a specified period. China has cut employer social security contributions which act in a similar way to a wage subsidy by reducing the overall cost of labor. China's measures are meaningful--for example, SME employers in Shanghai could see their wage bill fall by up to 30% for five months through June 2020. These policies can be effective because, unlike subsidized loans or corporate tax cuts, the benefits only pay out if workers are kept on the payroll.

…But Only For A Few Months

Job subsidy policies are only a short-term fix. We would expect incentives for these policies to wane after the initial six months proposed by some countries for two reasons. First, they are exceptionally expensive for governments. Second, they usually still impose a cash flow burden on firms. For both governments and firms, the cost-benefit trade-off will deteriorate over time.

The initial upfront fiscal cost of wage subsidy schemes can run to about 3% of GDP every three months (based on official estimates from both Australia and New Zealand). [10] This can be justified for a while because keeping jobs can accelerate the eventual recovery and mean lower fiscal costs in the medium-term. Tax revenues would be higher and welfare payments would be lower. However, the cost-benefit trade-off may change quickly as the schemes are extended.

First, more employers would seek to access the scheme as the recession broadened to other sectors. In most economies, private sector wages account for 60%-70% of GDP. Consider a scenario where 50% of the private sector was subsidized at 50% of total wages for six months and we get to a fiscal cost of over 8% of GDP. This is back-of-the-envelope but shows how the numbers could get very large very quickly. Second, the benefits would be pushed further into the future. At some point, this may encourage policymakers to review these schemes.

For firms, the schemes provide relief but only up to a point. In most cases, the subsidies are partial and employers need to pay that portion of the wage above the cap. As with governments, this can make sense if the costs of firing and then, later on, finding, hiring, and training new employees are high. But this trade-off also worsens as the crisis endures and, unlike governments that fund themselves in local currency with a pliant central bank, firms face hard budget constraints. At some point, the cash flow dries up and to survive, jobs will be cut.

Debt Does Not Go Away In A Recession, But Jobs Do

Job losses are obviously bad news but how bad will vary by country and one reason why is the level of household debt and households' capacity to keep servicing it.

Household debt as a share of GDP, while helpful as an indicator, may not be the right way to think about debt-servicing capacity. We should think more about flows-versus-flows and then what determines each of these flows. The numerator includes rolled over principal and interest costs. In local currency terms, the principal is fixed but the central bank can help push the rates lower. However, this gets harder the closer the policy rate is to the lower bound.

Most of the action will be in the denominator which is disposable income. Losing a job will substitute welfare payments for wages but a reduction in hours or even a partial wage subsidy will worsen the ratio. Even if a household retains its jobs and hours, if deflationary pressures lead to nominal wage cuts, again the ratio worsens. Only a few countries publish good debt-service ratios and among these, Australia and Korea appear most exposed. These two economies experience substantial volatility in unemployment and hours worked and start from weak positions with debt service ratios at about 15% and 11%, respectively. This puts both economies in the top quartile of a sample of 26 advanced economies.

This need not end in household bankruptcies but it would likely change consumer behavior. Borrowers may need to cut back on spending to keep servicing the debt. Even when life improves, there may be a preference to rebuild balance sheets, mainly by boosting saving. For example, in Australia, rising unemployment is almost always associated with a rising household saving rate. Again this will depress spending and, in aggregate, will mean a flatter recovery.

Chart 8

Household debt to GDP provides a broader sample of countries and the picture is not especially pretty for Asia-Pacific. Four advanced and three emerging market economies in the region are more indebted than their peer group global average.

Chart 9

These ratios do not take household assets into account which can be a mitigating factor (Australia is a good example). The distribution of debt is also important. The debt may be evenly distributed across the population or it may be concentrated in certain groups, for example, middle-income rather than low-income households. Still, debt does not go away in a recession but jobs do.

Labor-Market Scars Could Take Longer Than Normal To Heal

So what does all mean for the outlook? Here are our thoughts:

• The COVID-19 shock will put unusually intense upward pressure on unemployment rates and downward pressure on hours worked compared to previous recessions.
• In the absence of large and targeted wage subsidy schemes, we estimate that unemployment rates would rise by well over 3ppt across the region, much more than the typical recession.
• The more that unemployment rises, the more drawn out we should expect the recovery to be. This will largely depend on social distancing restrictions.
• Policies can help limit the damage and, so long as initial containment is achieved by end-Q2, the rise in unemployment capped at between 1-2ppts.
• Incentives for governments to offer these policies and employers to access them will wane the longer extreme social distancing measures endure.
• Job losses will hit household debt-servicing capacity, encourage higher saving, and lower consumption. Australia, Korea, Malaysia, and Thailand appear most exposed.
• With an increasing proportion of household income spent on services, this will drag on the service sector recovery even after social distancing measures are partly relaxed.

A Note On Our Coronavirus Coverage

S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak about midyear, and we are using this assumption in assessing the economic and credit implications. We believe the measures adopted to contain COVID-19 have pushed the global economy into recession (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Notes

[1] Organization for Economic Cooperation and Development (OECD), 2019, SME and Entrepreneurship Outlook.

[2] Gurría, Angel, 2018, "SMEs Are Key For More Inclusive Growth," OECD Observer No. 313.

[3] The change in unemployment was estimated using a vector auto regression including the log change in real GDP, the real policy rate, the log change in the real effective exchange rate, and the unemployment rate. The model was estimated using quarterly data from Q1-2001.

[4] Pissarides, Christopher, 2000, Equilibrium Unemployment Theory: Second Edition, MIT Press, Cambridge, Massachusetts.

[5] Blanchard, Olivier, and Lawrence Summers, 1986, "Hysteresis in Unemployment," NBER Working Paper #2035.

[6] Layard, Richard, and Stephen Nickell, 1985, "The Causes of British Unemployment," National Institute Economic Review.

[7] Ball, Laurence M., 2009 "Hysteresis in Unemployment: Old and New Evidence,"

NBER Working Paper, No. 14818

[8] Ohanian, Lee E., and Andrea Raffo, 2012, "Aggregate Hours Worked in OECD Countries: New Measurement and Implications for Business Cycles," Journal of Monetary Economics, Volume 59, Issue 1.

[9] Fagan, Colette , Helen Norman, Mark Smith, and María C. González Menéndez, 2012, "In Search of Good Quality Part-Time Employment," Conditions of Work and Employment Series, No. 43, International Labor Organization.

[10] Government of New Zealand, Government Takes Significant Economic Decisions as NZ Readies for Alert Level 4 in COVID-19 Fight, official press release.

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