State Aid Policies in Response to the COVID-19 Shock: Observations and Guiding Principles

Forum DOI: 10.1007/s10272-020-0902-4 End of previous Forum article Massimo Motta and Martin Peitz* State Aid Policies in Response to the COVID-19 Shock: Observations and Guiding Principles Thanks to COVID-19, markets have disappeared from one day to the next, and firms’ assets in most sectors have been rapidly depleting. This has increased the need for many firms to obtain funding. However, the ongoing economic uncertainty has made it even more difficult © The Author(s) 2020. Open Access: This article is distributed under the terms of the Creative Commons Attribution 4.0 International License (https://creativecommons.org/licenses/by/4.0/). Open Access funding provided by ZBW – Leibniz Information Centre for Economics. * This article is based on, but reorganises and adds to, Motta and Peitz (2020a,b). Massimo Motta, ICREA – Universitat Pompeu Fabra, Barcelona; and Barcelona Graduate School of Economics, Spain. Martin Peitz, University of Mannheim; and Mannheim Centre for Competition and Innovation, Germany. ZBW – Leibniz Information Centre for Economics for firms to obtain credit from the financial sector. Thus, firms that are profitable in normal times face liquidity problems as a result of a negative supply and/or demand shock, and the financial sector does not satisfy the individual needs for liquidity support because of the large macroeconomic risks. In such a case, governments have to step in and assist with liquidity support or the appropriate guarantees so that banks and other financial institutions can provide the needed liquidity. Governments may also design other support schemes that protect workers or help demand to recover. In the current crisis, there are no doubts that state support is necessary to avoid long-run consequences for firms, workers and their human capital. Many countries, including most EU member states, have announced various measures (and are considering new ones) to control the public health crisis and address the economic fallout due to the COVID-19 pandemic. State aid can be seen as a response to a system failure resulting from a severe economic shock, either hitting one sector (with possible contagion effects in other sectors) or – as in the case of the coronavirus crisis – simultaneously hitting several sectors. 219 Forum As a general principle, state aid to firms and sector-specific support schemes should be used only when there are market failures; that is, when there are good reasons to believe that the market would not deliver efficient and/ or equitable outcomes. Aid should also be effective and proportional to the aims it intends to achieve. While there seems to be wide agreement that government inaction is not an option during the COVID-19 crisis, a few observations may guide the design and revision of state support schemes. Sectors are hit differentially by the COVID-19 crisis It has been documented that supply chain disruptions and demand shocks have had differential effects on sectors (for the UK, see for instance Bloom et al., 2020). This implies that some sectors need very little to no support, while others are in dire need. Clearly, liquidity support can then be targeted so that only those firms in need of such support sign up for the support programme. This implies that firms unaffected by the shock do not have the incentive or the ability to move under the umbrella of a liquidity support scheme. This also applies to state assistance for the labour costs of a firm (in particular, covering a fraction of the costs of furloughed employees). Keeping viable firms alive and enabling them to keep their staff makes it possible to quickly restart and scale up economic activities when demand picks up again and supply constraints have disappeared. By covering part of the wage bill for unemployed or underemployed staff, there is an incentive for firms hit by the shock to participate in this support scheme, while firms not hit prefer not to do so. Thus, well-designed liquidity support and employment subsidies can be applied across the whole economy, provided they are effectively targeted in the sense that only those firms negatively affected will participate in the programme. Some firms were struggling even before the COVID-19 shock Some firms would have difficulties regardless, and the risk of a badly designed, overly generous support scheme is that it would keep those firms alive. The entry and exit of firms is an important process in any flourishing economy, as it leads to a better allocation of resources. Since such a view may be dismissed as ‘neoliberal’ in the public debate, it is important to reflect on what happens when non-viable firms are kept alive. Consider the following constructed example: a village has a zoning law in place such that two restaurants have a license to operate. Suppose that one of the restaurants serves lousy food and cannot pay its bills, while the other serves decent food. If the village authorities provide support to 220 the former so that it can cover its losses, the villagers will continue to be served lousy food in this restaurant. If this restaurant were to exit the market, a different restaurant may serve the villagers better food. This increases the competitive pressure on the other restaurant and encourages it to strive even harder. Therefore, state support schemes and in particular state aid that applies to a particular sector or to particular firms run the risk of supporting firms that are not viable in the long run even without the COVID-19 shock. It is therefore important that support schemes are temporary in nature. Also, to be eligible, well-established firms should provide evidence that their business was not in the red prior to the outbreak of the COVID-19 pandemic. In line with these two observations, the European Commission (2020a, 2020b) adopted a Temporary Framework for state aid schemes aimed at ensuring firms’ access to liquidity and finance, and at preserving employment. This framework provides some limiting principles, establishing the temporary nature of such public interventions, and favouring their effectiveness and their incentivising nature. For instance, firms that were already having difficulties on 31 December 2019, and hence before the crisis, cannot have access to most measures; credit guarantees for loans beyond €800,000 cannot apply to more than 90% of the loan; the loan principal should normally not go beyond certain amounts (25% of yearly turnover, or twice the yearly wage bill); and wage subsidies given to workers who would have otherwise been laid off because of the crisis should not exceed 80% of the monthly gross salary. Sectors and firms hit by a temporary shock may also be subject to a long-term shock Some industries may never look the same after COVID-19. If large portions of temporary shocks become permanent, state aid will become more problematic for the sectors or firms that aim to preserve the status quo ante. Given the large fiscal strains on many countries, we submit that such (...truncated)