The scale and scope of various government interventions around the globe in the aftermath of the COVID-19 outbreak have been nothing short of staggering. Programs have come in different forms: guaranteed loans, equity injections, bank loans to SMEs that can be transformed into government-financed grants, etc. The actions taken in the initial stages of the outbreak, necessary to fight the economic fallout, are bound to generate major spillovers going forward. Very high firm indebtedness is likely to be a major concern. One reason is likely to be the large number of insolvencies, thus raising a major question that policymakers will have to grapple with: will there be excessive liquidations from a social point of view? It is time to start asking these questions to prepare for this eventuality that can bring havoc to societies. In the paper “Efficient Programs to Support Businesses During and After Lockdowns,” Thomas Philippon makes the point that firm failures in times of high unemployment and when wages are downward rigid, such as the present environment, are likely to be inefficiently high and an optimal mitigation policy is required. Thomas theoretically shows how it is optimal for the government to offer a premium for the continuation of a firm (in the form of an extra haircut the government accepts) in order to induce efficient restructurings, liquidations, and continuation of otherwise viable firms. From a social welfare point of view, governments will not want to prevent all liquidations, but rather to nudge private incentives toward continuation when a firm is viable once the pandemic is over. The most important challenge: how to carry out optimal interventions when we know that governments have limited information about the quality of firms. The paper suggest that the government can use the behavior of private creditors to reach the efficient outcome.
Spotlight by Andrew Ellul
Photo courtesy of Thomas Philippon