The Economy on Ice: Preventing Economic Contagion

I propose a universal freeze on balance sheets.  This would be similar to a debt standstill but here applied to all obligations including rents and pension contributions.  For struggling firms, the policy will take the form of temporary cessation of activities that could have legal status and allow them to continue at the end of the period of lockdown. 

Post Date
07 April, 2020
Reading Time
5 min read



The COVID-19 pandemic is not only a health crisis.  The confinement of people to their homes has profound effects on the economy.  As economic activity slows down many firms find it impossible to meet their obligations to their suppliers, creditors, landlords and workers.  Unless, they receive financial assistance will collapse into administration.  

How the government responds to these challenges will affect not only the ability of people to meet their needs during the crisis but also the potential of the economy to recover after the crisis.  It is unavoidable that many workers will become unemployed during the crisis.  It is paramount to ensure that the vast majority of these losses are only temporary.

Recognising that the current crisis is not an ordinary macroeconomic downturn is a necessary first step.  During typical macroeconomic recessions financially struggling firms are the first to file for bankruptcy.  This is typically considered part of the process of creative destruction whereby the weeding out of financially weak or unproductive firms is followed by a regeneration process where new firms are born that are better equipped to withstand market competition and satisfy consumer demand.

In contrast, firms facing ruin now are those belonging to sectors directly impacted by the social distancing measures imposed by the government.  Such sectors include the hospitality sector (which in 2015 employed 2.9 million people around 9% of the labour force), the travel industry and high-street retailers.

The initial response of the UK government was to commit £330 billion to support struggling firms.  Some measures offer direct assistance. For example, small businesses are offered up to £25,000 cash grants while the COVID-19 Corporate Financial Facility buys short-term debt from large firms.  Other measures offer loans to firms to cover their short-term obligations.  For example, the Coronavirus Business Interruption Loan Scheme offers loans of up to £5 million to Small and Medium-Sized Enterprises (SMEs) guaranteed by the British Business Bank.  Among the measures to support workers who temporarily lose their jobs the government will cover 80% of furloughed wage costs, up to a cap of £2,500 per month.  

There are two problems with the above measures that have already necessitated new responses by the government.  The first problem is that small businesses find the new loans very risky.  In order to get access to these loans their owners have to post a personal guarantee for loans over £250,000 and given the uncertainty surrounding the current crisis and the underlying risks banks are not able to respond particularly generously.

The second problem is that the measures are reactive rather than proactive.  Offering partial relief to firms that are already in trouble does not prevent the transmission of problems to other sectors of the economy.   The collapse of a firm has direct implications for its customers and workers.  But by not being able to meet its obligations to its suppliers, creditors and landlords, it adversely affects upstream firms, the financial sector and the housing sector.

For example, last week British Airways announced that will suspend employment of 36,000 workers. That was immediately followed by an announcement by Airport services companies Swissport, Worldwide Flight Services, Dnata and Menzies immediately that 25,000 jobs are at risk.  Accordingly we have seen some of the largest increases in the unemployment number and claims for universal credit.

The government’s response follows a piecemeal pattern that cannot prevent the contagion of shocks from sector to sector.  To support those in financial difficulties the Financial Conduct Authority has asked banks to freeze their payments on loans and credit cards for up to three months.  However, this only transmits the problem to the banking sector, which will have to make provisions in many cases against these elements of support. 

Another good example of the piecemeal approach is the decision of the government to provide extra protection for businesses who miss rent payments by banning evictions.  In response the National Landlords Association is requesting the government to grant mortgage holidays.  If this request is satisfied expect banks to also ask for some type of relief.

The crucial point is that the government cannot bail-out the whole economy.  To do so will have catastrophic implications for the next few years as the government will struggle to finance its own debt.  However, not rescuing firms and thus not preserving the economy’s productive capacity is not a more attractive option.

An alternative plan in my recently published NIESR Policy Paper, proposes a universal freeze on balance sheets.  This would be similar to a debt standstill but here applied to all obligations including rents and pension contributions.  For struggling firms the policy will take the form of temporary cessation of activities that could have legal status and allow them to continue at the end of the period of lockdown. 

Under this alternative plan, the banking system’s role is to provide (a) clearing services for transactions between financially healthy firms that are still active, and (b) allow consumers to have access to their accounts.  Given that under this proposal insolvencies are completely avoided there is no need for the Bank of England to commit any funds for bailing-out firms.  Instead, they can introduce a scheme that facilitates the expansion of activities of those firms that are able to do so.  The funds committed under the existing policies for bail-outs will be used to support those workers who temporarily lose their jobs.

While the government cannot avoid the cessation of the economy during the crisis and this lockdown it should try to do more to reduce long-term damage.