Ten | Sam Bowman and Sam Dumitriu | March 20, 2020
The UK is shutting down, and a recession is inevitable. Rishi Sunak has vowed to do ‘whatever it takes’ to protect incomes, businesses, and jobs. But what should he actually do?
It is essential that he, and the British public more widely, realise that this is not a ‘normal’ recession like ones we experienced in 2008-09 or the early 1990s. If we treat this recession as a normal recession, it could cause lasting damage to the economy even after we end quarantine measures, and make it even harder to beat this virus before then.
In a normal recession, the government should generally not bail out failing businesses. Instead, while keeping the overall macroeconomy stable with monetary and fiscal policy, they ought to let insolvent and unprofitable businesses go bankrupt, bail-in banks, and support workers as they move to new jobs. We didn’t want Blockbusters and Woolworth’s to survive the Great Recession, we wanted capital and labour reallocated to Amazon and Netflix. Normally, we want a post-recession world to look different to the pre-recession world.
But this isn’t a normal recession.
First, it’s self-inflicted. When the Prime Minister tells us to work from home and avoid pubs, cafes, and restaurants, he is in effect calling for a reduction in economic activity. That’s absolutely right from a health point of view, but trying to ‘get the economy moving’ by using traditional stimulus policies is in direct conflict with this goal.
Second, it’s (probably) temporary. This will pass. We will eventually develop treatments and vaccines for this disease, or at the very least introduce a workable system to detect and contain it, and eventually life should mostly return to normal. Some sectors may be permanently less profitable, but most won’t.
Third, it doesn’t care if you’re profitable or solvent. There is no reason to think that good, as in profitable in normal times, businesses will be any more able to weather the storm better than bad businesses. In fact, the opposite may be the case – highly productive businesses that have higher overheads (like labour or rental costs) will be more badly hit than less productive businesses with lower overheads.
Fourth, it’s not failing businesses’ fault. Unlike in the financial crisis, where the promise of bailouts may have incentivised banks to take excessive risk, that kind of moral hazard isn’t a concern here. On this point, we agree with Jonathan Portes: “It’s hardly reasonable to suggest that your local Thai restaurant should have made a business plan that took into account the risk of a three month pandemic-induced shutdown.”
Fifth, there is no obvious private alternative. The costs of this shutdown are so large and so widely shared across the economy that it is difficult to imagine a private body that could insure against this risk. Insurance usually works when costs are not borne by everyone at once, so it can use the premium payments of those who have not incurred a cost to provide cover to those who have. When costs are borne by as large a group of people as these, the cost-shifting has to be across time, and in as large a case as this, only the state may be able to do that amount of cost-shifting. This, and the fact that they are mostly once-off, is why we are relatively relaxed about the cost of these measures: there may be some free market ‘nirvana’ where a private agency did the cost shifting, but in our world the state must act as the next best alternative.
Because of these factors, many of the remedies we would usually support during a recession may backfire. Our immediate aim should not be to prevent a sharp reduction in economic activity – unusually, this is the goal. We do not want people going out and spending in bars and restaurants. The economic priority is instead to facilitate this sharp reduction in economic activity, but doing so in a way that doesn’t cause long-term damage to the economy.
First, we should distinguish between two different kinds of business that may be threatened with bankruptcy during this period. Solvent businesses may still go bust without additional liquidity – government-backing for business loans is one solution to this, so that they can access credit. But the problem is much bigger than that. The financial hit of several months of low or no revenues, while overheads such as wages and rent still need to be paid, will push businesses that would otherwise have been solvent into insolvency. This is not simply a credit issue – the overhang of those costs means that as we come out of the downturn, many would struggle to pay back any debts incurred.
As for workers, many simply cannot work remotely. Most of them will either be laid off or have their hours cut significantly, with little prospect of alternative work for many of them. The short-term hit will be painful to anyone affected by this. And, if we expect to go back to normal at some point after this, it will be enormously wasteful.
As Steven Hamilton and Stan Veuger write, we don’t want to lose “the valuable things these businesses have worked hard to build—the products, processes, knowledge and relationships that make them unique.” Entrepreneurship isn’t easy. You can’t simply re-assemble a business overnight. And matching workers with the best jobs for them is a slow, difficult process – consider how long you have spent in your life looking for new jobs and carefully deliberating about the best option between different choices.
Economic policy when every day is like Sunday
To avoid this, we need a response that keeps much of the economy in stasis for the shutdown period. As much as possible, businesses should be kept alive and workers should stay attached except when normal factors might lead them to leave – a better offer elsewhere, say. The aim should be to keep as many existing business relationships alive and viable as possible, so that they can return to normality once the shutdown period is over. A temporary fall in economic activity need not lead to a depression. As Wojtek Kopczuk notes, “the economy does not collapse on weekends and it does not collapse in Europe in August when seemingly nobody works.” We should be aiming to keep our economy in stasis, so that it is in as good a position as possible to bounce back, almost as if we were an off-season seaside resort.
The policy response should be designed to protect businesses, protect jobs, and to protect affected individuals. Support for the unemployed and inactive self-employed will be important, but the priority is to keep workers on payroll, even if they can’t actually work. This could be achieved in a number of ways that could be rolled out soon, some using existing payment mechanisms and administration to act swiftly.
Remember that these are not intended to be economic ‘stimulus’ in the conventional sense of trying to increase economic activity. They are not really ‘macro’ policies at all. Rather they are policies designed to keep individual firms and workers afloat during the next few months - a ‘big micro’ approach, you might call it. We’re also relatively relaxed about large businesses that can access capital markets, and so in general can access support that way if they are long-term viable.
Saving businesses
First, we should be prepared to bail out small businesses – provided they keep their workers. Steven Hamilton and Stan Veuger have a novel proposal targeted at SMEs. Loans would be issued to cover any fall in revenue experienced by a participating business relative to previous years (with a benchmark level to be determined for new businesses). However, unlike the Business Interruption Loan Scheme announced by the UK Government, businesses would also receive a tax credit equal to the full loan amount including interest, provided that the business maintains its full-time-equivalent (FTE) payroll through the duration of the crisis. In effect, if a business does not lay off its employees they do not have to pay the loan back.The plan would also cap the net income (after tax credits) of businesses receiving the loan at a given percentage of previous years’ net income, to prevent companies from making windfall profits by cutting variable costs.
The benefit of this scheme is that it makes support for businesses conditional on keeping workers attached. The key drawbacks are that it’s untested and may be difficult to roll out quickly, because there are no existing institutions we can adapt to do it. Dr Michael Ryan of the WHO didn’t have the economic response in mind when he said that “perfection is the enemy of the good when it comes to emergency management. Speed trumps perfection”, but his logic applies here too. The challenge is putting something in place that will stop layoffs now. If this takes weeks to assemble, many businesses may start laying-off workers immediately. Making it clear, urgently, that this kind of structure will be in place may lead firms to hold off on layoffs, even if it takes a few more weeks to put it into place.
Second, a solution that may be easier to implement is to essentially ‘hack’ the statutory maternity pay system and apply it to all workers. The Resolution Foundation is proposing a Statutory Retention Pay (SRP) scheme in which people who don’t have work to do stay formally employed by their firm, but with a significant amount of their pay covered by the state. If the rate were set at 66% (and 80% for workers earning less than £189 a week), then it would cost £8bn if a million workers took part in the scheme. But we should be prepared to borrow and spend much more than that if necessary.
The scheme has parallels with the Danish response to the virus, where employers are able to grant a paid leave of absence to their workers. The government will pick up 75% of their salaries, with the employer paying the rest. At the same time, workers agree to give up entitlements to paid holiday.
Startups that are not yet bringing in revenue will need targeted support as they approach the end of their funding runways. They are ill-suited to taking on debt, such as the Business Interruption Loans, and are unlikely to benefit from rates relief or grants, as many use co-working spaces. Startups will be responsible for a large proportion of job growth once this is over, and cannot be overlooked.
Two measures should be targeted at them. First, grants aimed at small businesses that don’t pay rates should be extended to startups in co-working spaces. In lieu of accurate valuations, grants could be limited to at startups with fewer than 10 employees. Second, instead of loans the British Business Bank should back convertible notes of up to £500k for early-stage startups. The notes would convert to equity at a later date and avoid the problems of issuing loans for pre-revenue innovative businesses.
Protecting incomes and jobs
It is important to target businesses as well as individuals. The aim is not just to protect incomes but to ensure workers have a job to go back to.
A temporary basic income wouldn’t do this and would cost more. It would also be poorly targeted – many workers do not need support and transfers to them create additional tax burden in the future that need to be paid back, and that should be avoided if there are alternatives that can be better-targeted.
However, means-testing is difficult at the best of times, and impossible in this kind of circumstance. A ‘third way’ might be to, effectively, open the student loans scheme to any UK worker that wants to access it, allowing them to borrow money now to be paid back on an income-contingent basis over their lives. Under the current student loan repayment terms, earnings above a certain income threshold (currently £25,716/year) are taxed at 9% to repay the loan, with any amount unpaid written off thirty years after the loan was first taken out. The loan incurs an interest rate equal to a measure of inflation (RPI) plus 3%. We could offer different plan terms to people availing of this scheme, cap the amount at a realistic level to reflect average earnings, and the repayment term to a short period of, say, five years.
Low earners would probably never pay back the entirety of the ‘loan’ – since this is a one-off cost, that simply transfers lost income to them from other taxpayers, and it is arguably a feature of this scheme, not a bug. Most other people, depending on their earnings and terms decided on by the government, would pay back as and when they were able to.
The advantage of an approach like this is that it allows people to self-select into the scheme, eliminating any need for the state to try to decide who is and is not deserving of cash now.
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