Loan guarantees and their implications for post-COVID-19 productivity

Many countries introduced or ramped-up loan guarantee schemes to bridge liquidity shortages as a key element of the policy response to the COVID-19 crisis. The analysis in this paper discusses the potential short and medium-term effects on productivity of loan guarantees via reallocation, relying on historical data on European firms.

The findings suggest that, absent policy support, the COVID-19 shock had the potential to seriously distort market selection, as it would have raised sharply the probability to face financial difficulties across the whole distribution of firm-level productivity. The combination of standard policies such as job retention schemes and loan guarantee programmes counteracted this process in the short-term: by hibernating the corporate sector, it re-aligned the market selection mechanism closer to normal time standards, shielding many high productive firms from distress and supporting zombie firms only to a limited extent.

At the same time, however, large loan guarantee programs do not come without risks for future productivity, as they may favor the build-up of misallocation in the medium-term. The paper shows that, over 2007-2018, increases in large-scale loan guarantee schemes were associated with weaker reallocation of credit and labour from low to high productivity firms. Notably, this risk is consistently lower in intangible-intensive sectors and disappears for smaller scale programmes.

Finally, as pandemic-related support is phased-out, the authors identify two main areas for action to foster the recovery. First, the implementation of dynamism enhancing structural policies that spur firm entry and digital diffusion, while preserving competitive markets, is essential to countervail the potentially negative long run reallocation effects of the hibernation strategy. Second, a set of policy actions to keep under control the risk of debt overhang are also warranted, in particular to ease the repayment and roll-over of pandemic induced debt.

Click here to go to the paper by Lilas Demmou and Guido Franco.