The government’s coronavirus bailout should not be built on unaffordable loans

It is important to recognise when a situation presents nothing but bad options. That is what the government confronts when crafting its response to the economic firestorm generated by the coronavirus crisis. There are no easy ways to support an economy that may have fallen by 25 percent in the six weeks since lockdown and in the OBR’s mid-April scenario sees GDP over 13 per cent lower in 2020 than in 2019. Writing a report on bailout policy in the crisis (due out next week), I constantly had to remind myself that I was not looking for the perfect answer, because for such an economy there just isn’t one. Loans that are unlikely to be repaid act as a drag on both lender and borrower, but no finance ministry can offer up limitless no-strings payments.

It felt simpler in the immediate afterglow of chancellor Rishi Sunak’s Budget vow to do “whatever it takes”. A natural disaster, and the short “V-shaped” recession then expected to follow, provided the ideal justification for a short spell of unlimited Treasury support. None of the usual concerns about government generosity had to apply. This support couldn’t encourage irresponsibility, because no one could have prepared for coronavirus and it was hoped it would be too fleeting to distort markets.

It was possible then to imagine the ideal bailout policy. This would identify all the lost incomes that people and businesses would suffer, pay those sums to people while lockdowns were in place, and afterward welcome everyone back into the same economy as before, their livelihoods kept more or less intact. There is a strong economic rationale, too, that goes beyond simple solidarity; letting too many businesses go bust and workers laid off would hobble the economy for the rebound. The bill would come later – either companies repaying the loans used to tide them over, or the taxpayer working off the cheap debt incurred, in the case of grant money.

This was a policy that the government largely followed, through a mixture of tax holidays, grants, enhanced benefits, payments for furloughed workers and partially guaranteed loans – a suite of support assembled in record quick time, largely without the policy agonies and conditions that would usually plague a fiscal package of a tenth the size^[1]. By my estimate, the government arranged to take some two-thirds of the economic hit of coronavirus in higher debt.

The problem of low productivity awaits once the economic recovery gets underway

It no longer feels so simple. All these interventions usually have a downside, which is why we don’t normally bung money at any set of companies struggling with a big change. It impedes the process by which resources shift towards those activities the economy needs and can support long term. When a crisis is expected to be sharp but fleeting, it is possible to set these aside, but not if the economy is going to be forced to change. This change might come from two sources – the coronavirus itself, and the shock of the economic contraction. Some sectors will have to downsize, many companies will have to restructure or exit their market, and many people will have to shift jobs – whether or not it is politically palatable to say so.  

The Treasury needs to guard against a chaotic mass insolvency, but also has to keep an eye on preserving the economy’s dynamism. Britain’s longstanding productivity problem is not a short-term issue – as Andy Haldane of the Bank of England put it in a podcast with our director Bronwen Maddox, we actually need low productivity in the lockdown, as this means employment being preserved while output falls. But it will be there waiting for us when the recovery begins, and too much no-strings support can cause damage.

The chancellor should resist calls to raise his guarantee on small company loans to 100%

Another problem concerns loan support. There is a rising crescendo of voices calling on the chancellor to raises the level of the Treasury guarantee on the CBILS small company loan scheme from 80% to 100%. In my report I caution against this, particularly if the recession turns a liquidity crisis into one of widespread insolvency. The guarantee, remember, is for the banks offering the loan, not the company receiving it. This move would certainly make banks worry less about the consequences of their lending, and so shift money out of the door quickly, but it means a great many small companies taking on debt that they cannot afford. Even setting aside the risk of fraud, for the recovery this means a highly indebted small business sector labouring to repay its loans, rather than invest and grow.  

Fine, you might say: it is the government’s risk, and the aim is to avoid insolvencies by whatever means possible. But unaffordable loans create the worst of all worlds. As well as making insolvent companies even more insolvent, they impose an ongoing administrative and financial burden on borrower and lender. Better, in my view, to deploy the same resource in a different waysuch as direct grants or equity-style injections that do improve companies’ solvency. These would generous to the small company recipients directly, not the banks, and could be linked to the recovery through a future charge on profits, for example. And the government should begin work now on how to generate a broader recapitalisation of corporate Britain through the tax system.

The Treasury’s focus should be on whether its measures will support future economic growth

This is still no easy way out: no finance ministry can afford limitless payments with no strings attached. The Treasury still needs to develop metrics linking grant and equity support to a viable future economy. That still means tough negotiations, and many disappointed lobby groups. It is hard to see an exit from all this support without widespread insolvency.

I should end by reiterating this point about generosity. There will be voices warning against further support purely on the grounds of fiscal affordability. This is understandable – the deficit for the year ahead may break all records. But it takes little calculation to work out that the cost of an impaired recovery is far, far greater than a few tens of billions invested in business sector recapitalisation. Extra generosity may save the Treasury money – if it is deployed in the right way and keeps the UK economy vibrant. Not loans that are bound to go sour, but grants and equity that are more likely to help. Where the focus needs to be is not so much on the cost as the effectiveness, in terms of supporting future growth. For a Treasury forced so far from its comfort zone, that ought to be something of a relief.