What constrained firm investments in digital technologies during the pandemic?

Veliko Tarnovo Bulgaria 1 January 2021, souvenir and ticket office for medieval castle new years day walk
Editor's note:

This blog is part of a series using a survey of firms to assess the impact of COVID-19 on firms in Europe. The previous blogs can be found here and here.

While firms during COVID-19 accelerated the adoption of digital technologies, this adoption can operate through different pathways: expansion of digital platforms or investments in new digital technologies. In this blog, we analyze if there are specific barriers limiting some of these pathways, and specifically what barriers may have limited businesses investments in new in digital technologies in response to the pandemic. Did they lack awareness about the potential benefits of digitization? Did they lack complementary managerial capabilities to exploit digital technologies? Were they restricted in their access to finance? Did the uncertainty of future scenarios increase their perception of risk? Specifically, we explore how access to finance is important for investments in digitization by small and medium firms and how heavy debt can lower investments in the presence of high uncertainty. When the outlook becomes uncertain, government support is essential to smooth concerns about the future of business, sustain demand, and reduce volatility. Such interventions can be key to sustain a productivity-driven recovery built on the effective adoption of digital technologies.

Access to finance is crucial for firm investments in digital

In our previous blog we showed that during the pandemic firms turned to digital, but this expansion of digital technology can be done through alternative pathways. Firms can either expand the use of information communication technologies (ICT) that they already own and expand the use of platforms or invest in new technologies. These two alternatives differ in their potential impact on productivity but also in terms of fixed costs and financing needs. New investments require firms to incur significant fixed costs, while expanding the use of pre-owned technology or the use of digital platforms does require limited investments. In the three European countries analyzed (Romania, Poland, and Bulgaria) we find find that investment in new digital technologies is much less common than expansion in the use of digital platforms, and this pattern is driven by the choices of smaller businesses. In fact, while smaller firms are able to expand the use of pre-owned digital technologies and digital platforms just as larger firms do (left panel, Figure 1), they are three times less likely to invest in new digital technologies (right panel, Figure 1). Why is that?

Figure 1. Expansion of usage of existing digital technology vs. new investments by firms’ size

Figure 1. Expansion of usage of existing digital technology vs. new investments by firms' size

COVID-19 affected firms’ access to external financing, but it also hit their cash flows. The drops in sales hurt firms’ liquidity and constrained the availability of internal resources to finance the reboot and invest in digital (right panel in Figure 2). But firms adapted and exploited alternative coping strategies. For example, the more sales were affected the more firms redirected their production toward new products (product innovationleft panel in Figure 2).

Figure 2. Product innovation vs. investment in digital technologies

Product innovation vs. investment in digital technologies

Uncertainty heightens the perception of risk and lowers the willingness to invest, especially for firms in financial distress

The unprecedented circumstances brought on by COVID-19 raised uncertainty to historically unseen levels. Overall, firms that experienced higher uncertainty were less willing to invest in digital technologies compared to firms whose future revenues appeared more secure (left panel, Figure 3). However, uncertainty lowered the willingness to invest in digital and was particularly strong among financially distressed firms falling into arrears (right panel, Figure 3), suggesting that a mix between financial constraints and uncertainty may be a key reason for limiting investments in new digital technologies.

Figure 3. Investment in digital technologies, uncertainty in sales, and fear of falling into arrears

Product innovation vs. investment in digital technologies

Public policies can reduce uncertainty to support the recovery, including through digitization

Public support played a key role in influencing firms’ responses to the pandemic and, in particular, their choice to invest in digital technologies. The help firms received from the state counteracted the negative effects of uncertainty on investment. Firms that received assistance not only invested more often in general, but they did so even when future outcomes were more uncertain. This result is cause for some optimism as it suggests that governments can play a crucial role in smoothing the risks that firms bear and in supporting their recovery by, for example, enhancing their likelihood to invest in digital technologies. We will discuss how public support for firms was rolled out and how it helped firms in our future blogs.