What do you mean by “hibernating” firms? Is this one way to “freeze” the economy?
Assuming that the COVID-19 shock will eventually pass, some have argued for “freezing” an economy so that it can resume later. But is entirely bringing an economy to a standstill possible?
We propose “hibernating” as a way of avoiding the economic costs of breaking firms’ valuable relationships with their stakeholders and going into bankruptcy. Firms have relationships with an array of key stakeholders, such as workers, suppliers, customers, and creditors, that have been painstakingly built up and maintained over time. Avoiding the destruction of these relationships and the cost and time it would take to reestablish them is essential to ensuring a robust recovery.
To hibernate, a firm will need to be certain of having the bare minimum of cash necessary to withstand the pandemic lockdown and the social distancing measures. It will need to have just enough cash to preserve some relationships with stakeholders but adapt activities to avoid freezing the firms themselves.
To survive, a company might need to adjust payments down while ensuring that relationships remain viable in the long run. Policymakers would need to find ways to ensure that credit is available to firms that do not have cash on hand to get them through this period.
Workers will need a basic income, some firms will need to deliver essential products and services, and some maintenance and operations will have to take place; these will incur expenses. Think of an airline surviving the pandemic. The company cannot shutdown completely while most planes are grounded. It has to pay even for the planes to be parked and to be kept in flying conditions, such that it can resume operations when activity returns, without incurring even larger losses.
What considerations do policymakers have to bear in mind when designing this kind of a response?
Most governments have limited resources and will need to set priorities and be aware of trade-offs when deciding how to save firms from collapsing during the pandemic.
Should they emphasize helping large firms or should efforts be directed at small and medium enterprises? Are linchpins in value chains a priority? Should special consideration be given to firms whose relationships would be particularly hard to reestablish? Are some industries – infrastructure, health, or education – essential and therefore at the front of the line? Are industries hit hardest by the shock such as travel, tourism, and other services worth focused help?
The needs are urgent, and these decisions will have to be made quickly. Policymakers will also have to determine whether to condition assistance on maintaining certain relationships over others, such as requiring firms to keep workers on payroll but holding off on payments to shareholders. Determining which relationships are most valuable for a company is not trivial and hard to do for outsiders to the firm.
Is the timing of the policy response a factor in this approach?
Governments will need to time their support strategically. Firms might be in hibernation and need funds for several months to make it through the lockdown period – a time when private creditors may hold back and when government assistance might be needed the most.
Eventually, as surviving firms emerge from hibernation and need additional lines of credit to restart or jump-start their operations, private lenders might be more inclined to step in when uncertainty has diminished and they would be in a better position to assess firms' prospects and credit risks.
Are we equipped with the right financial infrastructure?
Existing legal and regulatory infrastructures (bankruptcy codes, crisis resolution mechanisms) are not designed to deal with external shock such as the COVID-19 pandemic, and in fact can amplify problems by penalizing firms in distress. In light of this, policymakers should innovate and reassess their financial policy responses while the health crisis gets resolved. This means working with the financial sector and adapting the financial infrastructure to improve the survival chances of viable firms. This is exactly how many countries are moving and experimenting on the policy front.
Your ideas suggest that responding to this crisis will require a very different approach from the past. Why?
The economic crisis triggered by COVID-19 is radically different from past economic and financial crises in that it did not originate in the financial sector and was not the result of firms or intermediaries behaving irresponsibly. It affects everyone. Also, the health emergency is transitory – at some point the pandemic will be resolved, albeit with large uncertainties about the timing and shape of the recovery.
Typically, the optimal response to a financial crisis is to quickly identify and isolate the part of the financial system that is in trouble. This time, however, most sectors of the world economy were in good health before the pandemic struck, so activating standard crisis-resolution mechanisms might actually curtail financing to firms instead of providing the temporary funds they would need to stay afloat. That is, identifying the “bad apples” that appear during typical crises is not a good recipe in this case. Many firms ran into trouble now because of an unforeseeable shock that paralyzed the economy.
There is a lively policy debate about the financing of firms during the pandemic, as many are pushed toward bankruptcy. Essential to this discussion is to decide what policy choices may be optimal given the challenges and trade-offs that policymakers face when trying to save firms from collapsing, as well as the incentives these choices will generate.
