Commentary Type

Europe's pandemic price tag to keep firms afloat

Testimony before the members of the Committee on Economic and Monetary Affairs (ECON) of the European Parliament


Honorable Members of the European Parliament:

Thank you for the opportunity to present some of my thoughts on the economic recovery from the COVID-19 crisis. I will make four points, presenting some empirical evidence to substantiate these.

Before I start, let me make one caveat. I was in your shoes during the last economic crisis in Europe, as finance minister in Bulgaria. The two crises have important differences. First, the COVID-19 crisis is truly global, happening simultaneously in the whole world. This limits the opportunity for companies to shift their sales from one market to another, as was largely possible during the eurozone crisis. The second big difference is that the COVID-19 crisis is at the same time a demand and supply crisis, while the eurozone crisis was primarily a crisis in demand. With these differences in mind, let me list my four points.

First, this crisis requires massive government spending.

Second, this spending is through infusion of money into the private sector.

Third, this money is best disbursed as interest-free loans through commercial banks.

Fourth, as the recovery accelerates—and this may only be next year and in some sectors in 2022—parliaments around Europe need to consider schemes of debt forgiveness for the private sector.

I will take each point in turn.

First, with some research colleagues I have run hypothetical estimations on the survival time of firms in the current crisis. We take their retained earnings and sources of external financing from last year, assume that these are all saved or remain available, and then calculate the burn rate by week. We also assume that firms only pay fixed costs—wages are fully taken up by the government. With these assumptions, we reach a startling conclusion: The median firm runs out of liquidity in two to five months. In service and construction sectors, two months; in heavy machinery, four to five months.

We then assume that some of the trade credit that exporters use may be reduced as international trade collapses. In this scenario firms even in the most resilient sectors have cash for 3.5 months. Finally, let’s assume that after July European firms on average operate at 50 percent of sales for the remainder of the year—a partial opening.

We use these scenarios to calculate what it would take to keep European firms afloat for the remainder of the year, assuming that governments already cover the wage bill. The answer: 3 to 4 percentage points of GDP. That’s about €750 billion, beyond the additional health costs and the additional resources needed for job retention and household incomes.

Second, this massive expenditure cannot simply go to large public works like highways and bridges and airports. This is because the whole corporate sector is suffering now, including especially the services sector. While it may seem odd to have a program supporting cafes and gyms, this is exactly what we need unless we are prepared to face huge unemployment. The late Austrian economist Joseph Schumpeter may say “don’t worry, the most productive firms will survive.” Not true in this crisis, as the most productive firms—typically found in export sectors—are especially hurt.

Third, the only conduit for a massive program like this is the banking sector. In some countries you can think of the tax system working in reverse and depositing money in firms’ accounts. But in many countries not all firms are taxpayers, or at least not regularly. Commercial banks have wider reach. This is also why I think interest-free loans are the right instrument—it would be odd for banks to give grants.

Fourth and final, another challenge awaits if we are successful in our previous steps. Firms will have survived the crisis but will be burdened with debt. Some will be unviable anyway—as their sectors are slow to recover—and have to close. These will not be able to pay off their debt. The majority will, however, want to reduce this debt to manageable levels. We do not yet know what these levels may be. We do know that some schemes need to be in place to partially forgive debt. We will know we have succeeded when we get to that point.  

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