The Day After Tomorrow. Designing COVID-19 Bailouts for a Sustainable Recovery

Governments around the world are taking extraordinary measures to mitigate the economic fallout of COVID-19. Their decisions in the weeks and months ahead will shape our lives for years to come. The fiscal packages that are being adopted as well as the funding that central banks are making available will have significant effects on livelihoods. They will determine whether money reaches the families most in need, whether small and medium-sized enterprises survive, and whether people can go back to their jobs after the shutdowns. They will have a critical impact on income and wealth distribution. And they will be at the core of shaping the structure of our economies and thus our environmental trajectory post-crisis.

Corporate bailouts are a central pillar in this context. In addition to financial assistance that is earmarked specifically for payrolls, the injection of cash through loans, equity, grants and debt guarantees are at the core of government support measures worldwide.

The United States is a case in point. The largest component of the US$2 trillion CARES Act is an appropriation of US$500 billion which authorizes the Treasury to provide up to US$25 billion in liquidity to passenger airlines, US$4 billion to cargo airlines and US$17 billion to businesses deemed vital for national security. The remainder of at least US$454 billion is earmarked to backstop emergency facilities established by the Federal Reserve to support lending to eligible businesses, States and municipalities. The CARES Act also introduced the Paycheck Protection Program with an initial envelope of US$349 billion – expanded last week by another US$321 billion – to provide “forgivable loans” to companies with up to 500 employees through their banks and with a full government guarantee through the Small Business Administration. Loan forgiveness is dependent on employee and compensation levels being maintained and equal to the amount spent on payroll, mortgage interest, rent and utility.

Across the Atlantic, state aid for businesses by EU Members as reported by the Commission now amounts to €2 trillion. Firms in Germany, as an illustration, have access to short-time work compensation as well as a range of credit facilities through their banks and the KfW Group – some fully hedged, some partially hedged by the government. The German government has also introduced a €600 billion stabilization fund aimed at providing liquidity to larger companies through debt, guarantees and equity – with detailed questions on design and conditionality currently being vehemently debated in the context of a rescue package for Lufthansa.

The short-term policy goal of bailouts is straightforward and widely supported: to avoid massive layoffs and safeguard economic capacity. At the same time, bailouts must also contribute to a sustainable recovery and the economic adaptation to new circumstances that it requires in the longer-term.

This is particularly vital in the current crisis.

Unlike previous shocks such as the 2008 Financial Crisis and the Latin American debt crisis in the 1980s, the current threat to livelihoods did not originate from financial fault lines, but from a pandemic. This distinction is crucial as it will result in lasting changes of human attitudes and economic structures. Physical distancing and the experience of online work over the last weeks will change travel patterns for years to come. Disruptions in supply chains will trigger a review and recalibration of trade flows. And the accelerated push towards further digitalization will shift the way we learn, work and consume.

Against this background, the bailout packages that governments decide on need to be both massive and smart. They must safeguard livelihoods both in the short as well as the long-term. They must reflect the fact that going back to the status quo ante is not an option. And they must help businesses adapt to new realities post-crisis and to come back stronger as we go through this storm.

Back to “Normal” is a Dead End

Balancing short-term priorities with a longer-term vision must thus be at the core of deciding who receives what amount of fiscal assistance and under what conditions. Aiming for a return back to “normal” is a dead end in this context.

Let us take the airline industry as a case in point. The sector is among the most affected by the crisis. Global air passenger demand has plunged 70% and industry revenues are estimated to shrink by at least US$252 billion in 2020. Crucially, the industry will go through a significant adjustment in its business model as travel and work patterns as well as supply chains are recalibrated. Bailout packages, such as the one currently discussed with Lufthansa as well as its subsidiaries SWISS and Austrian Airlines, the support provided by the French and Dutch governments to Air France-KLM, and the plans for a nationalisation of Alitalia must reflect this. They must also ensure policy coherence with other objectives. Targets for the reduction in greenhouse gas emissions from the sector are a case in point. As recently highlighted by the Austrian Minister of Environment, when bailouts are designed to assist an industry “that particularly needs to contribute to climate protection, then it makes a lot of sense to use this situation to support this transformation”.

Forward-Looking Bailout Principles are Critical

With this in mind, a forward-looking design of bailouts and the conditionalities attached to them are imperative. A recognition that government resources are not unlimited and need to be spent wisely must be at the core of financial assistance to corporations. Further principles must provide additional guidance to support a sustainable recovery.

To start, bailouts must prevent massive worker furloughs and layoffs. At the same time, aiming to retain 100% of payroll in all sectors is at odds with the structural changes we are facing. Striking a balance between the dual goals of safeguarding jobs now and securing employment opportunities in the longer-term is critical. Bailout packages must thus not only include provisions on the retention of workers and their compensation, but also provide for adequate human capital investment in line with the transition that individual sectors will be going through. Training and development of new skills to protect workers as digitalization, automation and shifts in supply chains change our economies must be a core element of that.

Bailouts must also ensure that taxpayer money reaches workers and helps companies to run their business. Provisions to ensure that government assistance does not flow out the back door through dividend payments or share buybacks are an essential first step in that direction. Capping bonus payments, limiting salary increases, and constraining pay gaps between the highest and the lowest paid workers in a company, are further measures to consider.

Building up resilience must be a further goal. COVID-19 will not be the last shock to the global economy. As the policy responses to the current crisis highlight, solid government institutions and fiscal space are essential to mitigate economic breakdowns. Tax revenues are vital for that. Conditionalities – as introduced, for example, by Argentina, Canada, Denmark and Poland – that preclude companies using tax havens from public assistance underline the fact that governments need tax revenues to provide support in a crisis. Further measures to foster tax transparency should also be on the agenda.

The same holds true for corporate financial buffers. Whereas the financial crisis of 2008 has highlighted the need to raise capital requirements in the financial sector – a goal that has been partially, but only partially achieved – financial buffers in the real economy have received little attention. They are now, however, hitting radar screens around the world as companies seek government support after having distributed significant parts of their cash-flow to investors leaving them with depleted reserves to weather the current storm. A Bloomberg report published last month showing that the largest US airlines spent 96% of their free cash flow over the last decade to buy back shares provides a sobering illustration. Bailouts as well as post-crisis debates on capital requirements must reflect that the need for buffers is not just an issue for the financial sector, but also for the real economy. They must also address the moral hazard which is inherent to the support of companies which have retained less capital and liquidity buffers to absorb shocks than their competitors.

Finally, bailouts – in particular larger bespoke ones – must ensure coherence with further core policy goals and a country’s vision of its economic, social and environmental trajectory. A conscious alignment of financial assistance with government roadmaps on infrastructure, digitalization, innovation, social cohesion and environmental protection must rank high on policy agendas in this context. Those who raise concerns about the lobbying that underpins such choices as well as the ability of governments to pick winners, make a valid point. However, as long as bailouts are on the agenda, that point misses the key question, which is not whether governments make choices, but – as highlighted recently by Frank Elderson from the Dutch central bank – whether they choose to prop-up the economy of yesterday or to build the economy of tomorrow.

Balancing these different dimensions of the crisis response is both a herculean task and critical. Securing pathways through the current storm and fostering a sustainable long-term recovery is vital. The design and conditionalities of corporate bailouts are a central pillar for that. Building capacity to monitor their use is crucial. Transparency on who receives them at what conditions is essential to secure public scrutiny and accountability – and thus making sure we deploy taxpayer money wisely to mitigate the current hardships and come back stronger on the day after tomorrow.