Co-authored with Emmanuel Saez, professor of economics
Coronavirus threatens the world’s economic life, and current proposals from governments around the globe are failing to match the scale of the crisis. Today, the chancellor, Rishi Sunak, [UK Chancellor of the Exchequer] announced £330 billion of loans and that some companies would not have to pay business rates for the next 12 months.
While loans help businesses in the short term, they do not compensate for losses and only allow companies to smooth costs over a longer period.
In the United States, the Trump administration has suggested direct cash payments to individuals. Such measures (such as $1,000 given to each U.S. household) help to alleviate temporary economic hardship but are poorly targeted: It’s too little for those who lose their jobs, and it is not needed by those who don’t. During social distancing, the goal should not be to increase demand, since people can no longer spend on many goods and services.
Unemployment insurance, or benefits, and paid sick leave policies come closest to helping laid off workers and those unable to work, but they do not prevent redundancies and do not help businesses. Tax relief, such as the business rate holiday offered by the UK to sectors most affected by the recession, such as hospitality and retail, will help. But there’s no guarantee this relief will be enough to prevent bankruptcies and job losses.
There is, however, a radical and targeted solution to the specific causes of the coronavirus global recession: governments should step in as payers of last resort, which means they would cover wage and maintenance costs for businesses facing shutdown. In the context of this pandemic, we need a new form of social insurance, one that directly helps both workers and businesses.
So, how does this work in practice? The drop in demand caused by social distancing measures, and a following decrease in output and therefore GDP, is expected to be short, probably for a few months. Governments cannot undo this direct output loss, but they can prevent a very sharp but short recession becoming a long-lasting depression.
Absent government actions, and many businesses and workers do not have enough liquidity to weather dramatic shortfalls in demand causing mass redundancies. Keeping businesses alive through this crisis and making sure workers continue to receive their wages is essential.
The most direct way to provide this insurance is to have governments act as payers of last resort, so that hibernating businesses can keep paying their workers (known in economic terms as idle workers) instead of laying them off, and can keep paying their necessary bills such as rent, utilities and interest instead of going bankrupt.
In practice, in the US, the unemployment insurance system is already up and running, making it possible to compute and deliver compensation to idle workers. Workers should immediately start receiving special unemployment insurance benefits so they are no longer a cost to their employers — even though they stay formally employed — and no re-hiring process is needed once they can come back to work.
Self-employed individuals (such as gig workers) could report themselves as idle and be eligible for this special unemployment insurance. In case of partial idling — if someone’s working hours have been cut — unemployment insurance benefits would be prorated.
These benefits would be progressive if they replaced a higher fraction of earnings for low-paid workers. This is a desirable feature, as low-paid workers are more likely to be affected by the lockdown (i.e., less likely to be able to work from home) and less likely to have savings to replace a temporary loss in earnings.
In the payer-of-last-resort program we envision, businesses on lockdown would report their monthly necessary costs of maintenance and receive payment from the government.
Necessary costs are rent, utility payments, interest on debt, health insurance (in the U.S.) and national insurance contributions (in the UK) of idle workers, and other costs that are vital for the maintenance of businesses. For partially shut down sectors, governments would pay a fraction of the maintenance costs. The amounts don’t need to be exact; verification and correction can take place once the lockdown is over. Any excess government payment could be transformed into an interest-free loan that could be recouped over several years.
There are two reasons why such a policy would work in the case of the coronavirus pandemic. First, it is clear what is driving the shock: a health crisis that has nothing to do with any business’s decision and will be temporary. Second, different industries are affected differently. That’s in contrast to normal recessions, where the drop in demand is widely spread and has no clear timeline.
How much would such a payer-of-last-resort program cost? Based on national account statistics by industry, we estimate that with a nationwide lockdown up to 30% of aggregate demand could evaporate in the US over the next three months, leading to a 7.5% drop in annual GDP.
Compensating idle workers and necessary business maintenance costs would involve government payments of around half of this total. Unemployment insurance replaces about 50-60% of wages, and essential maintenance costs of businesses are probably less than half of their normal operating costs (for example, non-flying planes do not burn fuel). The total cost for the government would be around 3.75% points of GDP, financed via an increase in public debt. The direct output loss from social distancing measures would in effect be put on the government’s tab, i.e., socialized. A payer-of-last-resort program will work if it is limited in time (e.g., three months), so the cost remains manageable and business decisions are not affected.
It would not fully offset the economic cost of coronavirus. No matter what governments do, there will be real output losses. Even if airline workers are paid, the plane rides won’t happen. For other sectors, supply-chain distortions will happen no matter what, due, for example, to quarantine measures.
But a payer-of-last-resort program would alleviate the hardship on workers and businesses. It would maintain the cash flow for families and businesses so the coronavirus shock has no secondary impacts on demand — such as laid-off workers cutting down on consumption — and a quick rebound can take place once demand comes back. Business activity is on hold today, but with an intravenous cash flow it can be kept alive until the health crisis is over.