Avoiding Economic Long-COVID: Policies to Support Firms and Workers in Latin America and the Caribbean

During the peak of the COVID-19 crisis, governments in Latin America and the Caribbean aided firms and households with support packages coordinated with central bank monetary policy. For many, liquidity injections and flexible financial sector supervision helped ease the pain.

While many small firms closed their doors during the crisis, surprisingly few larger firms failed. Instead, they survived by cutting costs and forgoing investment, depleting their productive capital in the process. Debt levels are as high now as they were before the pandemic. At the same time, the persistent impacts of the virus and new strains, Russia’s war in Ukraine, monetary tightening in advanced economies, volatile international markets, and fears of global stagflation (low growth and high inflation) together create a highly challenging environment.

The Center for Global Development and the Inter-American Development Bank joined forces on a report released today that examines the challenges firms faced during the COVID-19 crisis and recommends potential solutions. The report is based on the deliberations of an expert working group of top economists and lawyers from countries in the region. We hope its recommendations will assist policymakers and international financial institutions in identifying and implementing actions to spur renewed investment by productive firms, support the growth of new ones, and improve labor market performance.

Investment and Informality: A Dual Problem

Investment in the region fell sharply during the darkest days of the pandemic. While the flow of investment—especially in mining, oil and gas, agriculture, and manufacturing—has since recovered, firms’ fixed assets (their productive capital stock) have fallen across the board. Corporate debt levels soared but, to finance additional liquidity and survive the crisis, very little of that was invested. Debt has now fallen, but only to pre-pandemic levels.

With their future output threatened, will firms be able to finance investments and rebuild their capital stock to at least pre-pandemic levels? Volatile international capital markets, rising global interest rates, and concerns about a global recession complicate the picture. They make it improbable that firm revenues will continue to rise well above pre-pandemic levels or that firms will be strongly positioned to raise more debt or attract more direct investment in the form of equity.

Productivity in the region has long been stagnant, and the large proportion of smaller firms relative to larger firms in the wake of the pandemic is unwelcome news. Smaller firms tend to be less productive and less able to take advantage of the transformative, productivity-enhancing capacities of digital technology.

In addition, while more informal jobs than formal jobs were lost during the pandemic, informality has come back strongly and is now more prevalent than ever. Informal workers tend to be less productive than their formal counterparts, and many work in micro firms with very little capital. Higher informality will put a further drag on productivity and growth.

Combatting Structural Problems During the Recovery

How can policymakers support productive firms and improve the functioning of formal labor markets? The CGD-IDB report offers suggestions for addressing these problems.

Countries should consider creating a public-private institution with a time-limited mandate and a professional staff hired largely from the private sector to support firms with strong growth potential. This institution—which could take various forms, such as a fiduciary fund—would evaluate and develop techniques for identifying firms with good business prospects and provide support through a range of instruments, including equity injections.

Countries in the region should also reform their insolvency codes to make them more flexible, transparent, and efficient. Such reforms could help ensure that investment flows from untenable, lower-productivity firms to larger, more innovative and productive ones. Along these lines, a new forum to provides technical support for national resolution processes, including for smaller countries that lack expertise, could make a considerable difference while assisting in cross-border insolvency issues. Investment protection should be strengthened, including through mechanisms that facilitate consultations between countries and investors to advance common aims and avoid disputes.

Policymakers should push to advance the transition to digital technologies, including through potential new investment in digital infrastructure and incentives for firms to digitalize. And short-cycle programs for technical training should be introduced, possibly including scholarships for students from poorer households.

Labor market reforms are critical, given the persistence of informality and its recent growth at the expense of formal employment. Reforms could include, among other features, financing social security and health benefits from more general taxation to reduce hiring costs for formal labor; lowering labor taxes; and introducing well-designed savings and insurance schemes that would support workers through periods of unemployment rather than protecting their jobs.

Latin America and the Caribbean faces long-standing structural problems, with a poor allocation of resources contributing to low productivity and low growth. The pandemic has aggravated these problems. We hope this report and its recommendations will help policymakers and international financial institutions take the needed steps to enhance firm recovery, economic growth, and employment and put the region on a prosperous and sustainable track.


CGD blog posts reflect the views of the authors, drawing on prior research and experience in their areas of expertise. CGD is a nonpartisan, independent organization and does not take institutional positions.