A new policy toolkit is needed as countries exit COVID-19 lockdowns (Bruegel Policy Contribution, Issue No. 12, June 2020)
Summary
A Bruegel Policy Contribution, Issue No. 12, dated June 2020, by Olivier Blanchard, Thomas Philippon and Jean Pisani-Ferry, previously published as PIIE Policy Brief 20-08. It argues that as governments move from lockdown to exit, measures focused on protecting workers and firms must shift toward balancing protection with reallocation between sectors. Section 1 describes the measures taken in Europe and the United States, including job-retention arrangements modeled on Germany's Kurzarbeit. Section 2 proposes an architecture combining unemployment benefits for workers, wage subsidies and partially guaranteed loans for firms, and a process-light restructuring of legacy debts. An appendix works through numerical examples of how haircuts for a bank and the government could be set in such a restructuring.
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Policy Contribution
Issue n˚12 | June 2020
A new policy toolkit is needed
as countries exit COVID-19
lockdowns
Olivier Blanchard, Thomas Philippon and Jean Pisani-Ferry
Executive summary
Olivier Blanchard is When it became clear that the COVID-19 pandemic required widespread lockdown of all
a Senior Fellow at the but essential firms, most governments took measures to protect vulnerable workers and firms
Peterson Institute for from the worst effects of the sudden drop in activity. These measures included unemploy-
International Economics ment benefits, grants, transfers, loans at low rates and tax deferrals. Their nearly exclusive
focus was protection. As lockdowns are lifted, as some of these measures come to an end, and
as it becomes clear that some sectors will have to contract and others expand, the focus must
Jean Pisani-Ferry is a progressively shift. As usual in the aftermath of a major shock, protection must be balanced
Senior Fellow at Bruegel with reallocation, taking into account changing prospects for sectors and firms. Incentives
and a Senior Fellow at must be given to firms and workers to resume activity, and, when needed, to adjust. Debt
the Peterson Institute for inherited from the freeze must be restructured if unsustainable. But policymakers must also
International Economics. consider the consequences of heightened uncertainty about the course of the pandemic and
Thomas Philippon is a the economy, and the large increase in the number of workers out of work.
Professor at NYU Stern
School of Business In other words, as governments in advanced economies move from freeze to exit, they
must design measures that will limit the pain of adjustment. This Policy Contribution explores
how such measures can be designed.
The authors thank Agnès
Bénassy-Quéré, Nick Bloom, Section 1 briefly describes the measures that were taken to accompany the lockdown, in
Laurence Boone, Benoît particular in Europe and the United States. Section 2 presents the protection and reallocation
Cœuré, Jason Furman, architecture that should underlie the new measures, namely a combination of unemployment
Selma Mahfouz, Jeremy benefits to help workers, wage subsidies and partially guaranteed loans to help firms, and a
Stein, Jean-Luc Tavernier, process-light restructuring of legacy debts. Section 3 concludes.
and PIIE and Bruegel
colleagues for comments
and criticisms on a previous Recommended citation
version of this paper. This Blanchard, O., T. Philippon and J. Pisani-Ferry (2020) 'A new policy toolkit is needed as
Policy Contribution was countries exit COVID-19 lockdowns' Policy Contribution 12/2020, Bruegel
previously published as PIIE
Policy Brief 20-08.
© 2020 Peterson Institute for
International Economics.
1 Initial measures
Initial responses to the coronavirus crisis were broadly similar across European countries,
while the United States took a somewhat different approach.
Helping workers
In Europe, the main measure to help workers was the introduction or scaling up of job-reten-
tion schemes inspired by the Kurzarbeit (short-time work) scheme that Germany used ex-
tensively to fight off the employment consequences of the Great Recession. See Appendix A,
table A1, for details on job retention schemes in selected countries1. Details and the generos-
ity of the schemes differ across countries, but the essentials are alike: employees on furlough
keep their contracts with their employers and take a small pay cut; the government pays the
largest part or the entirety of the cost to the employers.
Conceptually, these are systems of non-work benefits for salaried workers, extending the
standard unemployment insurance system in three ways:
1. Allowing workers to work part time, with the state paying benefits in proportion to the
time not worked;
2. More importantly in the current context, allowing workers to remain formally with the
firm even if not working at all, a benefit to both the worker and the firm when activity
starts again;
3. Allowing for more generous non-work allowances than the typical unemployment
benefits.
Given the exceptionally large increase in claims at the start, the issue of how to actually
distribute these non-work allowances turned out to be central and was solved in more or less
similar ways in European countries. The firm pays the benefits, usually in proportion to the
employee’s wage, up to a ceiling. As the benefits are somewhat lower than wages, workers
take the loss unless the firm decides to top up the allowance. The state reimburses the firm,
hopefully soon after the firm has paid workers. Government refunds to firms are usually sub-
ject to minimal requirements, but in Germany they are conditioned on a collective agreement
at the firm level.
These schemes have resulted in the state taking charge of the payroll cost of employees
made idle by the lockdown. Take-up has been immediate and spectacular. Most of the drop
in hours worked has been absorbed by the increase in the number of workers under these
schemes rather than by a rise in unemployment. By relying on firms to pay workers, the
schemes have proven efficient at reaching workers quickly. In France, 1 million employers
applied to potentially enrol 12.9 million employees (nearly two-third of the business pay-
roll). The actual take-up has been lower but still significant, with 8.6 million workers enrolled
at some point during April, of which about 4 million were on complete furlough2. Small
and medium-sized enterprises (SMEs) and hard-hit sectors have massively resorted to the
scheme. In the hotel and restaurant industry, about 70 percent of employees were on partial
unemployment (chômage partiel in French) at the end of April. The French government
estimates the cost of the programme to be around 1 percent of yearly GDP; depending on the
take-up rate and the length of furlough, it may end up higher.
1 According to the Organisation for Economic Co-operation and Development, 89 percent of OECD countries have
relied on schemes intended to help firms adjust working time and preserve jobs. See the OECD’s Employment and
Social Policy Response Tracker available via http://www.oecd.org/employment/.
2 Ministère du Travail, Direction de l’animation de la recherche, des études, et des statistiques (DARES) 'Activité
et conditions d’emploi de la main d’œuvre (ACEMO)-Covid survey', 20 May 2020. Employers first apply for the
scheme, then declare monthly how many workers were put on chômage partiel.
2 Policy Contribution | Issue n˚12 | June 2020
In the United States, the government has relied instead on a combination of grants to
all households below a certain income level and unemployment benefits for those laid off.
Reaching workers this way has proved difficult. Unemployment offices, put in charge of
paying benefits, have often been overwhelmed by the increase in claims.
Helping firms
In Europe the measures put in place to help firms have taken the form of a combination of tax
deferrals, guaranteed loans and equity injections. Germany launched a €600 billion economic
stabilisation fund that combines €400 billion for liquidity guarantees, €100 billion for
subsidised loans, and €100 billion for equity injections (Appendix A, table A2). In France the
main tool (in terms of size) has been the provision of credit through bank loans, with a state
guarantee to banks of 80 percent for loans to large firms (more than 5,000 employees) and
90 percent for loans to smaller firms. The price of the guarantee varies between 0.25 percent
and 2 percent over time and banks have committed to lend at cost. By the end of May more
than 3 percentage points of annual GDP had been granted in loans to more than 400,000
businesses3.
The United States has again adopted a somewhat different approach. It has mostly relied
on a programme of bank loans to SMEs, which can be partially or totally turned into govern-
ment-financed grants as a function of the proportion of workers kept by the firm (or laid off
but rehired before June 30) and so acts as a combination of loans, grants and wage subsidies4.
Implementation has been chaotic, however: signoff on loans by the administrative author-
ity and distribution by the banking system have been uneven; firms are served on a first-
come, first-served basis without regard for size.
In addition to those measures, both the United States and Europe have introduced ded-
icated programmes, often in the form of grants, to support self-employed individuals and
start-ups.
Unsurprisingly, the European schemes better protect workers and better preserve existing
matches between firms and employees. They have also proved to be more flexible, as firms
can, on a weekly basis, adapt their payrolls to actual demand and regulatory constraints.
The US scheme is more complex and less protective, especially as laid-off workers may
lose access to health insurance, and it does not favour the preservation of the employer-em-
ployee match. But it includes stronger incentives to restart.
Whatever their differences, all these support mechanisms raise the same questions:
should exceptional job retention and credit schemes be discontinued or made less generous
in the post-lockdown phase? Should they be made less attractive to employers, employees
and lenders? Should new support instruments be introduced instead?
2 Protection and reallocation
The challenge in the post-lockdown economy will be to combine protection and reallocation
in a context in which the nature and duration of the shocks are highly uncertain, unemploy-
ment is initially very high and there are few opportunities to find new jobs, firms have a hard
time obtaining credit, many firms are likely insolvent or nonviable, and government interven-
tions face the reality of limited public resources.
In this context, we explore the right mix of policies and argue that it should include a
gradual phasing out of job-retention schemes and the phasing in of sectoral wage subsidies
3 Ministère de l’Économie et des Finances, ‘Tableau de bord des mesures de soutien aux entreprises’, 2 June 2020.
4 The United States also has an Employee Retention Credit scheme, but eligibility is strict and it covers only 50 per-
cent of the wage cost up to $10,000. Tax deferrals have also been introduced.
3 Policy Contribution | Issue n˚12 | June 2020
to create incentives to resume production. Credit guarantees for new loans should continue,
albeit with decreasing generosity and perhaps some equity participation by the state. Given
the likely increase in the number of insolvencies, a process-light loan restructuring pro-
gramme should be put in place. We propose an automatic restructuring process with public
haircuts indexed to private ones but with a continuation premium to provide incentives to not
close firms.
Let’s start with the special nature of the shocks. So long as physical distancing remains
needed, many firms, especially in the service sector, will face both adverse productivity and
demand shocks. Productivity shocks and at least part of the demand shocks should, however,
largely disappear as firms adapt and when better drugs are discovered or vaccines become
widely available. The issue then is whether these firms should be largely kept alive until this
is the case. Other shocks, however, are likely to be longer lasting. The increase in teleworking,
which was triggered by the crisis, may become partly permanent, with implications for trans-
portation, urbanisation, and the like, which we are just starting to discover.
In normal times, policies should help the reallocation process, letting some firms fail and
others expand, and helping the reallocation of workers across sectors. These are not normal
times, however. Many firms may fail because they are insolvent even if they are viable. Given
the very high uncertainty, banks may be reluctant to advance credit. Unemployment is
extremely high, making it difficult for laid-off workers to find other jobs. For these reasons we
think that protection (of workers) and preservation (of firms) should be given a higher priority
than in normal times. At the very least, policymakers should proceed with caution and shift
only gradually the emphasis onto reallocation and liquidation.
Helping workers: adjusting job-retention schemes
Currently, job-retention schemes probably enrol a fourth to a third of private sector employ-
ees in several European countries. The schemes are typically more generous than general
unemployment insurance and have a somewhat different goal. They aim to provide income
to nonworking employees while protecting the employment relationship. Conceptually, they
protect mostly the worker, but also the firm.
These schemes worked well during the lockdown. Protection did not come at the cost of
job search, as job offers collapsed and there was little point in searching. Where job retention
schemes are in place, they should be maintained rather than discontinued. But three types of
adjustments are in order.
First, allowances to workers on these schemes should gradually converge to the standard
level of unemployment benefits. As vacancies increase and unemployment decreases, job
searching will become more relevant, and more incentives must be given to unemployed
workers to explore alternative jobs. This suggests maintaining the link between workers and
firms to make rehiring easier, but reducing over time the generosity of payments to workers
to align them with general unemployment benefits. From an equity standpoint, there is no
reason to provide a higher indemnity to workers on protracted furlough than to those laid off
by their employers.
Second, incentives for firms should be tilted toward restart. Under the existing regimes,
unless firms decide to top off what the state pays (a voluntary option that many firms do not
choose), they do not pay for non-work allowances: the state does. Put another way, there is no
cost to firms to keep their workers on furlough, and when they put a worker back to work, the
cost of doing so is the full wage. To give firms an incentive to take workers back to work, the
government could reduce its contribution to non-work benefits, while increasing the contri-
bution made by firms. This, however, would have two effects. It would make it more expensive
for firms to keep workers on furlough, and thus, other things equal, induce firms to rehire
those workers. But other things would not be equal. The payment for part of the non-work
benefits would increase overall labour costs for firms. This increase in labour costs, in the face
of adverse productivity and new fixed costs (associated with investments in workplace safety
and the lower productivity implied by physical distancing), would go in the wrong direction.
4 Policy Contribution | Issue n˚12 | June 2020
Tightening the screw on job-retention schemes could precipitate layoffs. We believe instead
that wage subsidies are a better way to proceed, and we return to this below.
The third adjustment, which is less important conceptually but turns out to be empirically
relevant, concerns fraud. Kurzarbeit and chômage partiel were initially designed for manufac-
turing companies wanting to adapt to a drop in output by temporarily reducing working time.
The problem with its application to a large number of SMEs is that it makes fraud particularly
easy. An employer can, for example, claim benefits for half the time of a given employee while
asking her or him to work full time. This suggests a gradual tightening of eligibility for job
retention when it applies to only a fraction of the working time5.
Helping firms: introducing wage subsidies
Even after the lockdown has ended, firms will often suffer from negative demand and produc-
tivity shocks. Many firms will need to introduce special arrangements to protect employees
and customers, decreasing productivity. In certain sectors, regulations will mandate service at
a fraction of normal levels. These constraints will most likely last in some form until vaccines
are widely available.
Should these firms be helped until physical distancing constraints are removed? A formal
analysis is given in Appendix B, but the conclusions are easy to state: in normal times, the
answer would be to let the firms survive or close and let laid-off workers reallocate. In today’s
environment, there is, however, a strong case for wage subsidies, based both on the high
unemployment rate and the temporary nature of the productivity and demand shocks due to
physical distancing.
With the exceptionally high level of unemployment from which economies start after
lockdown, workers who are laid off are likely to have a hard time finding another job and thus
could remain unemployed for a long time. Put more formally, the shadow price of labour
is very low. From a social efficiency point of view, firms should make decisions based on a
comparison between the marginal product of a worker and this shadow price rather than on
the comparison between the marginal product and the wage. If the wage cannot be cut, or at
least cut substantially (and for the same reason as there are unemployment benefits, wages
should not be cut substantially), wage subsidies are needed to lead firms to take the socially
efficient decision.
To the extent that some of the shocks are clearly temporary – even if their duration is
uncertain – there is a second argument for introducing wage subsidies. Suppose that in
the absence of such subsidies, most of the firms in a particular sector did not survive, but,
when the shocks were gone, the sector went back roughly to its pre-crisis state, requiring the
creation of many new firms. The costs involved in this process of destruction-creation might
be very high. If the expected duration of the shock is not too long, allowing most of the firms
to survive is likely to be a better social alternative. Restaurants provide a clear example. By
decreasing the number of customers restaurants can accommodate, physical distancing
constraints imply a substantial decline in productivity and many restaurants are unlikely to
survive a sustained period of lower productivity and lower demand6. Decreasing their costs
and allowing most of them to survive until the shock is gone probably dominates widespread
bankruptcies and later wide-scale reconstruction.
Without a shadow cost to public spending, reflecting the lower shadow price of labour
and thus subsidising all firms, whether or not they were subject to shocks, would be desira-
ble. It would, however, be extremely costly fiscally, and thus the focus should primarily be on
firms that are suffering temporary shocks and are unlikely to survive without financial help.
5 In France, this also calls for lowering the ceiling for eligibility to chômage partiel: For workers paid 4.5 times the
minimum wage, the definition of working time tends to be elusive, which facilitates fraudulent behaviour.
6 In Spain, for example, during the first stage, restaurants will be allowed to serve on terraces only and at a maxi-
mum of 30 percent of capacity. In the second stage they will be able to serve meals inside but again at a maximum
of 30 percent capacity. See the government’s Plan de desescalada published on 28 April 2020.
5 Policy Contribution | Issue n˚12 | June 2020
The list of such sectors is nearly identical in all countries: accommodation and food services;
arts, entertainment, and recreation; passenger transportation, especially airlines; retail trade,
partially; and, to a lesser extent, construction. Depending on the perimeter, these sectors rep-
resent between 4 and 9 percent of GDP7. Assuming a wage share, including social insurance
contributions, of 70 percent and a subsidy rate of, say, 30 percent, implies a gross fiscal cost of
0.8 to 1.9 percent of GDP.
The net fiscal cost is likely to be much smaller, however, even plausibly negative if the sub-
sidies are well targeted. If each wage subsidy led to the employment of an additional worker,
the state would save in both reduced unemployment benefits and increased social contribu-
tions. Together, these would most likely exceed the wage subsidy by a large amount. In reality,
targeting is likely to be far from perfect, some firms may benefit from the wage subsidies but
not increase employment, but the net fiscal cost is nevertheless likely to be small.
The logic of our argument implies that, as unemployment decreases and vacancies
increase, these wage subsidies should be reduced over time and that they should obviously
end if and when physical distancing constraints are removed. In principle, the adjustment
should be state-contingent and stopped if lockdowns must be implemented again, or if
unemployment remains very high.
Helping firms: loan guarantees
State guarantees on bank loans to firms were introduced to ensure emergency access to
liquidity. But even after the lockdown ends, there is a strong case for maintaining partial guar-
antees on loans8. In the current environment, which firms will survive and which will have to
close is difficult to assess, and if banks cannot fully diversify credit risk, they will ask for too
high a risk premium or refuse to lend altogether. Also, because of the effects of the lockdown,
most banks have seen a decrease in their capital ratios, making them more reluctant to lend
even to viable firms that may be short on liquidity. The government can alleviate this prob-
lem by providing partial loan guarantees. It is in general in a better position than banks to
diversify credit risk and to absorb the macro risk due to uncertainty about the evolution of the
pandemic and the availability of a vaccine. It should offer partial guarantees rather than full
guarantees or direct government lending: when banks share losses they do not have incen-
tives to lend to bad credit.
Most countries implemented such programmes during the lockdown. As countries exit the
lockdown phase, these loan guarantee programmes should be continued, with two modifica-
tions.
First, the generosity of the guarantees should decrease over time. As with job-retention
schemes and wage subsidies, the decrease should be contingent on the state of the economy.
The guarantees are justified by the extreme macroeconomic and microeconomic uncertainty
created by the pandemic. As the pandemic risk becomes easier to manage, the guarantees
should be phased out.
Second, the use of state guarantees should be linked to restrictions on dividend payments
and/or higher future corporate income taxes. Dividend restrictions are already commonly
imposed on large firms that require government support.
There might be excessive uptake from firms that do not need the guarantee but, because
they have good credit, this would not be costly to the government. The fiscal cost of guaran-
tees decreases steeply as they become less generous because of the direct effect as well as the
indirect effect via bank incentives. If the guarantees are reduced over time, maintaining a loan
7 Narrow definition: hotels and restaurants, airlines and ground transportation excluding trains, museums and
shows: 4.2 percent for France. Larger definition: same, plus half of the retail sector, rail transportation, home
services, leisure sports, and one-third of construction: 8.7 percent for France.
8 For a general discussion of loan guarantees, see Thomas Philippon and Philipp Schnabl (2013) ‘Efficient
Recapitalization’, Journal of Finance 68, no. 1, for the case of debt overhang; and Thomas Philippon and Vasiliki
Skreta (2012) ‘Optimal Interventions in Markets with Adverse Selection’, American Economic Review 102, no. 1, for
the case of adverse selection and stigma.
6 Policy Contribution | Issue n˚12 | June 2020
guarantee programme is unlikely to create a problem for public finances. The main danger
is the transfer of pre-existing exposures. A bank with an exposure to a firm could ask it to use
the guaranteed debt to repay its existing loans. This would be a transfer of risk to the state. A
simple remedy (which is already in use) is to require banks to maintain their existing expo-
sure as a condition for making a guaranteed loan.
Firms could be offered the option to convert guaranteed credit into equity or quasi-equity
in the form of preferred shares or, for privately held firms, higher profit taxes in the future. The
advantage for shareholders or firm owners would be to improve their balance sheets by low-
ering debt and increasing the equity buffer. The advantage for the state would be to improve
the viability of firms and lower the risk of costly defaults. For smaller firms, quasi-equity in the
form of an agreement to pay higher taxes in the future might be preferred to proper equity,
as the latter requires more monitoring and there is a limit to the extent to which the state can
manage a large number of small equity claims.
Note that, like wage subsidies, guaranteed loans are not designed to save all firms. By
reflecting the low shadow price of labour, and by pricing credit more correctly, they are
designed to induce firms to take socially efficient decisions. Even with the subsidies and the
loans, some firms are likely to be insolvent or unviable. Thus, the last leg of our architecture
focuses on restructuring.
Restructuring
Dealing with the legacy debts from the crisis will be complex and expensive. There are various
ways in which restructuring can be organised, depending on the seniority structure of private
and public claims, information problems and administrative burden.
As they exit the lockdown, firms will differ in their health and some will have excessive
debt levels. Firms in the post-pandemic environment can be thought of as being in one of
three baskets:
• Privately viable (the present value of their profits exceeds recovery value) and solvent (the
present value of profits exceeds current debt);
• Not viable and thus not solvent; and
• Viable but have been made insolvent by the shock and thus need debt restructuring.
If the firm is viable and has little or no debt, then the only issue is to make sure that it can
access liquidity to finance its operations. The guarantees described above should take care of
this. We thus focus here on the case where liabilities are large – the firm is insolvent and may
or may not be viable.
Even with wage subsidies and loan guarantees, the social value of a firm as a going
concern may substantially exceed its private value. Even for firms that receive them, wage
subsidies may be too small to cover the difference between the wage and the shadow value of
unemployment. Also, network effects in a fragile and depressed economy are more relevant
than usual, as the bankruptcy of a firm may have major effects on its suppliers and their
consumers. The implication is that private creditors will, by themselves, close too many firms
because they consider only the private value of the firm.
In addition, the number of firms needing debt restructuring is likely to be large and the
courts are likely to be overwhelmed, so standard insolvency procedures will not work. The
government, as one of the creditors, has neither the information nor the administrative
capacity to implement efficient restructuring by itself. It must work with private creditors (typ-
ically banks in the case of SMEs) that have more granular information and a better capacity to
use it. The process should thus be as quick and simple as possible, ie quasi-automatic. A large
number of parties should not be involved in complex bargaining.
Given these constraints, we propose the following scheme:
7 Policy Contribution | Issue n˚12 | June 2020
• If a firm is closed, the government claims the full extent of its rights as a creditor. This
should be known in advance so that creditors take this stance into account when making
their own decisions.
• If a firm continues but needs restructuring, the government automatically accepts a hair-
cut on its claims (deferred taxes plus guaranteed credits) equal to the haircut agreed by
private creditors of the same rank plus a fixed continuation premium.
The government may also turn its debt-like claims into equity-like claims.
The use of a continuation premium, and thus a higher haircut for the government than
for the bank, addresses the difference between the social and the private value of the firm
and leads the bank to make the right social decision. The bank takes into account that, if it
restructures the firm instead of closing it, it will benefit from a more generous haircut from
the government (a more detailed discussion and the analytics behind this conclusion are in
Appendix C).
In theory, the continuation premium should be equal to the difference between the social
and the private value of the firm; if so, letting the bank choose its haircut without further gov-
ernment intervention will lead to the socially optimal decision9. This approach induces effi-
cient triage, preserving socially viable firms without subsidising zombie firms. One variation
on this scheme is that the government can decide to first turn part of its claim into equity, in
the form of higher corporate tax rates in the future, for example. By giving up its senior status,
the government can make the restructuring process even simpler, but at some fiscal cost.
Doing so in turn allows for a lower haircut by the bank.
The limits of the theoretical argument are clear. Assessing the value of the continuation
premium is difficult. But it suggests a general strategy: using a rough number for the contin-
uation premium – say, a haircut higher than the bank haircut by 30 percent – and then letting
the bank decide. If it appears to be fiscally too expensive, the government can decide to offer
a less-generous continuation premium, say 20 percent instead of 30 percent. That will still
induce the private sector to save the most viable firms.
Implementation of such a scheme requires close attention to legal and operational details,
which vary from country to country. The government will normally hold senior claims on
companies resulting from tax deferrals, as well as more junior claims, including the guar-
antees. A straightforward approach would be to proceed separately for each seniority class.
Alternatively, the state could forgive its senior status in exchange for a larger haircut by the
banks.
Whatever the details, the state should resist the temptation of discretionary intervention
in the restructuring of SME debt. Although it may have the expertise and the experience
required to negotiate the restructuring of claims on mid-cap companies with creditors and
stakeholders, this does not apply to SMEs. It would be hard to resist political pressures and to
ensure consistency in the treatment of individual cases. Governments should instead define
a menu of clearly pre-specified options and let the main creditor bank take charge of the
restructuring. If the menu of options is well defined, banks will be led to choose the socially
optimal solution.
Finally, the state should implement this policy swiftly. Procrastination would only increase
uncertainty.
9 This statement is not quite correct. As is well known in corporate finance, if the owner can be replaced, the bank
will not consider the value of the firm to its owner. This issue arises in general and can in principle be offset by the
use of a higher continuation value. See Appendix C.
8 Policy Contribution | Issue n˚12 | June 2020
3 Conclusion
The measures taken by governments to protect vulnerable firms and employees during the
lockdown have largely met their goals – more so in Europe than in the United States.
As the exit phase begins, policy should pivot toward supporting the recovery. On the
demand side, this may require further fiscal support. On the supply side, this implies putting
gradually more emphasis on backing up productive jobs and viable companies while begin-
ning to phase out existing schemes. The inflexion should be gradual, because there is consid-
erable social value in preserving existing jobs and firms. Flexibility should be retained so that
emphasis can be switched back to protection in the event of a second wave of the disease. But
the direction should be clearly indicated.
In this spirit, this Policy Contribution has sketched the architecture that should underlie
those policies. From the mapping of general principles to specific measures that we are exam-
ining in the case of France10, we realise that the practical implications will differ across coun-
tries, reflecting differences in the initial set of measures, different administrative capacities,
different bankruptcy legislations, different fiscal constraints and different taxation systems.
But we believe that our principles are general.
In particular we make the case for introducing two new instruments. First, we propose
temporary wage subsidies to support sectors and firms severely hit by adverse demand and
productivity shocks. They would help limit layoffs in these sectors and the corresponding
increase in unemployment. We believe that if properly designed, their cost can be limited.
Second, we propose introducing debt-restructuring procedures for SMEs handicapped
by excessive legacy debt. Rather than relying on ordinary bankruptcy procedures (which are
inefficient and would take considerable time as courts are likely to be overwhelmed), we
propose incentives for private creditors to work out restructuring plans of viable but insolvent
SMEs where government claims receive automatic haircuts conditional on the banks them-
selves accepting a (less stringent) restructuring. This would help efficient companies to restart
and invest.
We see four main advantages to this strategy. First, reliance on these two instruments
makes it possible to tailor public support to a variety of situations. Some firms have no
balance sheet problem but suffer from added costs that weigh excessively on their operating
account; some are profitable but overburdened by debt inherited from the period in which
they had to stop operating. To address these two types of problems with a single instrument
would be inefficient and costly. Second, our strategy is flexible as it makes it possible to
respond in real time to changes – including possibly reversals – in public health conditions
and their implications for production. Third, our approach minimises the use of limited
administrative capacity and limits the risk of the state being overwhelmed by a wave of busi-
ness failures. Fourth, our suggested method addresses the political economy risk of capture,
which is inherent to discretionary interventions.
10 Olivier Blanchard, Thomas Philippon and Jean Pisani-Ferry (2020) ‘From freeze to exit: General principles with an
application to France’ (in progress).
9 Policy Contribution | Issue n˚12 | June 2020
Appendix A
Job retention and credit guarantee schemes, selected countries
US UK Germany France
Name Paycheck Protection Coronavirus Job Kurzarbeitgeld Chômage partiel /
Program Retention Scheme activité partielle
Principle Guaranteed bank Government refunds Government refunds Government refunds
loans to SMEs 80% of gross wage of 60% of net wage of 84% of net wage of
convertible into grants furloughed workers furloughed workers furloughed workers
if employer retains or (67% for workers with
rehires workers children)
Employee No requirement 80% of pre-lockdown 60/67% of pre- 84% of pre-lockdown
compensation wage lockdown wage wage (100% at
minimum wage)
+ firm top-up + firm top-up
+ firm top-up
Government refund 100% of actual wage 80% of pre-lockdown 60/67% of pre- 84% of pre-lockdown
bill wage per employee lockdown wage per wage per employee
(plus supplement for employee (100% at minimum
non-payroll costs) wage)
Social insurance Refunded Refunded Exempted Exempted for wages
contributions below 3 times the
minimum wage
Eligibility SMEs (less than 500 All firms All firms (minimum All firms
employees) 10% of workers have
working hours cut by
10%)
Maximum wage Payroll cost capped at £2500 per month €4687 per month €5485 per month (4.5
$100,000 per employee times the minimum
wage)
Conditions Credit distributed by Agreement with the Collective agreement Authorization of
commercial banks employee government agency
Grant conditional on
staff headcount at
end-lockdown
Work requirements No requirement No work during hours No work during hours No work during hours
covered, no other covered, no other covered, no other
work work work
Number of enrolled
employees (date)
10 Policy Contribution | Issue n˚12 | June 2020
Credit guarantee schemes
US UK Germany France
Name Paycheck Protection Coronavirus Business Wirtschaftsstabiliesierungsfond Prêt garanti par
Program Interruption Loan l’État
Scheme + KfW Special Program
Principle Government-financed Guarantees Guarantees on bank loans + Guarantees on bank
bank loans to SMEs subsidized KfW credits loans
convertible into grants
if employer retains or
rehires workers
Coverage of 100% 100% up to GPB 250K, 90% for small firms; 70% for 90% for small firms;
guarantee 80% above large ones 80% for larger ones
Rate 1% fixed rates. Lenders Interest holiday for 12 Several sub-schemes with Interest holiday for
compensated by months. Thereafter different rates 6 months
government terms set by lender
Low rates thereafter
Maturity 2 years Up to 6 years Up to 5 years 1 year, extendable to
5 years
Eligibility SMEs (less than 500 SMEs All firms All firms
employees)
Termination 30 June 2020 31 December 2020
Appendix B
Wage subsidies
Consider the following much simplified economy.
Decompose time into four periods: pre-lockdown, lockdown, post-lockdown but pre-
vaccine, and post-vaccine.
Assume that there are three groups of firms: those not affected by the shock; those affected
temporarily during lockdown and post-lockdown, but not post-vaccine; those affected
permanently.
Assume firms produce output with labour. Pre-lockdown, productivity per worker is
the same for all firms, and so are the wage and shadow wage (the wage equivalent of being
unemployed). Productivity is equal to the wage and the firms make zero profit.
Productivity remains the same throughout in the first group. During lockdown and post-
lockdown, productivity is lower for the other two groups. Post-vaccine, productivity returns to
its pre-lockdown level for the second group but continues to be lower for the third group.
The wage remains equal to 1 throughout. The shadow wage is lower during lockdown and
post-lockdown, reflecting high unemployment. It returns to 1 post-vaccine.
Assume that the cost of opening a new firm in the post-vaccine world equals C. We want
to find what subsidies in the post-lockdown period achieve the socially optimal outcome.
Optimal policy in post-lockdown period
Suppose that policymakers know exactly each type and outcome. Then, the first group of
firms is not affected and there is no need to intervene.
For the second group, the choice is either to have firms produce in the post-lockdown
period and the post-vaccine period, which, assuming no discounting, has value (X’ – B’) +
(1 – 1) = X’ – B’; or to close the firms in the post-lockdown period and open new firms in the
post-vaccine period, which has value 0 + (1 – C – 1) = –C.
The socially optimal decision is therefore to keep firms in the second group open during
post-lockdown if X’ – B’ > –C or, equivalently, X’ – B’ + C > 0.
Turning to private decisions, a firm in the second group will decide to stay open during
post-lockdown if X’ – 1 + S > 0, where S is the wage subsidy. Thus, for private decisions to be
11 Policy Contribution | Issue n˚12 | June 2020
socially optimal, the subsidy must be equal to S = 1 – B’ + C.
Under the assumptions in the table, as Y”< 1 and wage (W) = 1, firms in the third group
will close post-vaccine. The question is whether they should stay open in the post-lockdown
period. The same reasoning as above implies that they should stay open if Y’ > B’, while the
private decision implies that they will stay open if Y’ + S > 1. Thus, for the outcome to be
socially optimal, the subsidy to the third group of firms must be equal to S = 1 – B’.
Suppose now that we do not know if a firm belongs to the second or the third group.
Assume that there is probability p that it belongs to the second group, probability (1 – p) that it
belongs to the third group. Then, the optimal subsidy must be equal to S = 1 – B’ + p C.
In words, the optimal subsidy must reflect the low shadow wage, the probability that the
shock is temporary, and the cost of opening a new firm. Note, importantly, that it does not
depend on the actual shortfall in productivity. The purpose of wage subsidies is to induce
firms to take the socially optimal decision, not to save all firms. Whether firms close or not
depends on whether the subsidy is enough to make them viable; even with wage subsidies,
firms with a large shortfall will still close. For the firm to remain open, one should have
(1 – X’) < (1 – B’) + C, ie if the productivity decline is inferior to the sum of the drop in the
shadow price of labour and the cost of reopening.
Appendix C
Restructuring process
Let V be the privately discounted value of the firm, normalized by the pre-lockdown level
of assets. Let R be the recovery value of the assets in case the firm is closed, D the debt from
banks (or bonds if a large firm), and L the loans obtained from the government. A firm is (pri-
vately) viable if V > R. A firm is solvent if V > D + L. We normalise all values by the pre-crisis
book value of assets, so V, D, L, and R should be interpreted as ratios.
Our framework recognises that there are two separate constraints:
Net present value constraint
Because of risk premia related to pandemic uncertainty and because of other externalities
(unemployment, impact on the network of suppliers and customers, congestion externalities
in courts), there is a gap between the social value of the firm (Vz) and the private value V. V is
the maximum economic value that can be paid out to claimholders.
Vz = V + Z. We can think of Z = Vz − V as a measure of the social externalities.
Financial constraint
Because of debt overhang, incentives, and financial distress costs, private firms operate effi-
ciently when V − E > D + L, where E is the equity cushion.
In most economic models, E takes the form of a capital requirement or a net worth con-
straint. In practice it depends on the industry and is likely higher in bad times.
Economic triage: First best
The government has two goals:
Ensure the survival of socially viable firms
This means that, ideally,
If V + Z > R, the firm should continue;
If V + Z < R, the firm should close.
Protect taxpayer money
This means that, ideally, the government should subsidise only firms that would otherwise
not be privately financed. It should pay Z to firms whose value is such that
V<R<V+Z
Total cost G = Z*Prob(R − Z < V < R) + losses on existing loans.
If the government knew V, Z, and R, it would do the triage in two steps. For firms that need
12 Policy Contribution | Issue n˚12 | June 2020
to close, recovery would be R. Assuming pari passu risk sharing, banks and private creditors
would recover D/(D + L)*R and the government would recover L/(D + L)*R.
For firms that should survive, if V > L + D then all is fine. If V < L + D then a haircut (h) is
needed. Assuming pari passu we would set (1 − h)*(L + D) = V − E to get the haircut and leave
the firm with enough equity to operate. Firms where V > L + D > V − E are excessively lever-
aged and might need pre-emptive restructuring. So an alternative is to treat all firms with V
− E < L + D as needing a haircut.
Implementation with limited information
The main issue is that the government does not know V or R. Banks and firms know a lot more
about V and R than the government does.
This implies that the government needs the help of banks to implement efficient triage.
However, letting the banks make privately optimal decisions would lead to excessive closures.
Banks have three options:
1. Continue financing the firm if V > L + D; no haircut.
2. Close the firm and recover D/(D + L)*R.
3. Continue financing but if V < L + D then accept haircut h such that (1 − h)*
(L + D) = V − E. Hence the bank gets (1 − h)*D = D/(D + L)*(V − E), which is its pari passu
share of the pledgeable value.
From the bank’s perspective the decision to close under pari passu is thus
D/(D + L)*(V − E) < D/(D + L)*R, which is equivalent to V – E < R.
Comparing this to the optimal decision V + Z < R shows that two inefficiencies lead to
excessive closure:
1. Equity value E is ‘not pledgeable’ in the sense of standard corporate finance. This is a
private inefficiency that is well known.
2. Z is not internalised by the banks. This is a public externality issue.
Let us now figure out how to implement socially efficient restructuring. Suppose that the
government agrees to take a higher haircut (H > h) than the banks under continuation. Under
liquidation the government maintains its pari passu status. The haircut making a bank indif-
ferent between closing and continuation is 1 − h = R/(D + L). This then requires
(1 − H)*L = V − E − R*D/(D + L)
To implement the socially efficient triage, this condition needs to hold when V + Z = R.
Therefore (1 − H)*L = R − Z − E − R*D/(D + L). The haircut accepted by the government is given
by 1 − H = R/(D + L) − (Z + E)/L. Therefore
H = h + (Z + E)/L.
Proposition: Implementation under limited information. The following scheme
implements the first best allocation:
• If a firm is closed, then government loans (L) and private loans (D) are treated pari passu.
• If a firm continues but needs debt forgiveness then the government accepts to take a high-
er haircut than the banks, given by H = h + (Z + E)/L.
The key point here is that H does not depend directly on V or R, thus it is feasible even if
the government does not know V or R. The government indexes its haircut (H) to that of the
private sector (h) precisely in order to extract information.
This programme costs more money to the government than under full information
because it has to give up more of its claims to induce efficient continuation. But it achieves
the efficient outcome.
When the government also gives out wage subsidies, then the net present value of these
13 Policy Contribution | Issue n˚12 | June 2020
subsidies should be deducted from Z.
Fiscal equity
Governments have fiscal equity in all firms: the present value of future income taxes. They
have an incentive to keep the firm alive. In theory, fiscal equity could be adjusted to increase
the efficiency of the programme.
One way to make the programme less expensive is for the government to get relatively
more equity in exchange for accepting a higher haircut. For large firms this can be nonvoting
preferred stock; for small firms, it could take the form of a higher tax rate on future profits for
firms that need restructuring than for those that do not. For instance, suppose the govern-
ment forgives all corporate taxes due during the lockdown. All firms benefit from this meas-
ure. Those that default on their loans would agree to waive some of the corporate tax break.
That would be fiscal equity.
An example
Consider a firm before the lockdown with sales of 100 per year, non-labour costs of 50 includ-
ing maintenance, and labour cost of 40. Its total costs were 90, net profits 10, discount at 10%.
Firm value was V0 = 100. Debt was D = 50. Entrepreneur had equity E0 = 50.
During the crisis the firm gets an emergency loan from the government equal to L = 50.
Total debt is now D + L = 100.
After the crisis the value of the firm is lower. Future sales are only 75. It manages to lower
its non-labour costs to 40 and its labour cost to 30. Its total costs are now 70; profits are 5. The
new firm value V = 50. Since 50 < 100 the firm is insolvent.
Suppose that the minimum required equity is E = 10. The pledgeable continuation value V
− E is only 40. In addition, if workers are fired, their outside value is not 30 because the labour
market is depressed. It is only 20. That means Z = 10.
Finally, assume that the recovery value of the assets is R = 44. Under liquidation, the bank
would therefore get ½*R = 22. This is the outside value for the bank, and any continuation
must provide at least that value for the bank.
Suppose there is no programme and D and L are pari passu. To continue the business we
would need to reduce the total debt to 40. Each party would get 20 and the entrepreneur 10.
This would be lower than the liquidation value, and the bank would decide to close the firm.
But because V + Z = 60 > 44 the government would want to keep the firm open. If the gov-
ernment knew V and R, it would hold the bank to its outside option of 22 and would accept 18
to keep the firm open. The minimum cost to convince the bank to continue is an extra haircut
of 2 = 4%*50.
However, the government does not know V and R, so that is not feasible. Instead, the
government tells the bank: If you agree to continue, I agree to a haircut equal to yours plus (10
+ 10)/50 = 40%. The bank accepts. The bank can then estimate the required haircut (1 − h)*100
− 0.4*50 = 40 so h = 0.4. The bank accepts a 40% haircut from 50 to 30, and the government
accepts an 80% haircut from 50 to 10. The total claims are 40: E = 10, V = 50.
The haircut is large because the programme is designed to save all socially positive pro-
jects. Consider a marginal firm, for which R = 60 = V + Z. It is barely worth saving. The bank’s
outside option would be 30, which is exactly the value it gets under continuation.
If government funds are limited it might not be optimal to save a marginal firm. The
government could propose a continuation premium of only 20% instead of 40%. In that case
the marginal firm (R = V + Z) would be closed, but the firm in our example would be saved at
a lower cost: (1 − h)*100 − 0.2*50 = 40 leads to h = 50%. The bank would get 25, which is more
than 22 so it would be happy to continue. The government would accept H = 70% and get 15,
which is more than the 10 it was getting under the more ambitious programme.
Finally, if the government could obtain an equity claim (say of 50%) it could lower the
internal buffer from E = 10 to E = 5. That would increase pledgeable funds and lower the cost
of the bailout.
14 Policy Contribution | Issue n˚12 | June 2020
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