Rich and poor countries alike are facing an unprecedented economic crisis as they attempt to contain the impact of the COVID-19 pandemic. A downturn of this magnitude can cause tremendous long-term damage, with critical economic linkages between employees, businesses, and banks at risk of disappearing forever.  Scores of firms will close permanently unless urgent action is taken.  The threat is even more significant for emerging economies, where the economic costs of social distancing are likely to be higher, and where vulnerable small and medium sized enterprises with low cash reserves account for a much larger share of the economy than in rich countries, which can rely on extensive social and economic safety nets. Poor countries, moreover, have far more precarious health-care systems. The funds required to support vulnerable workers and businesses, and to care for COVID-19 patients, could be as high as 10% of their GDP. As a comparison, in the US the rescue measures passed in the last month alone account for at least 10% of GDP, and are likely to increase even more.^[1] A number of European countries have commited loans, equity injections and guarantees up to 35% of GDP.^[2]   

The COVID-19 crisis has led to a sudden collapse in capital flows to emerging and developing countries. According to estimates by the Institute of International Finance, non-resident portfolio outflows from emerging market countries amounted to nearly $100 billion over a period of 45 days starting in late February 2020. For comparison, in the three months that followed the explosion of the 2008 global financial crisis, outflows were less than $20 billion.^[3] 

Advanced economies can borrow large amounts at little extra cost. Moreover they benefit from flight-to-safety funding from foreign investors and from U.S. investors liquidating their foreign holdings. In other words, the financing that the U.S. and other advanced economies rely on comes in part from emerging market economies where, ironically, the financial needs are more pressing. What’s more, in contrast to the 2008 global financial crisis, every emerging and developing economy now confronts greater borrowing needs at exactly the same time. Even if a country like Mexico were able to issue bonds, it would be competing with many other countries at the same time. The reality is that countries have no one else to borrow from but other countries.

Left to their own devices financial markets will pick winners and losers. The winners will be those countries that already have enough borrowing capacity. They will be able to borrow large amounts at rock-bottom interest rates. The losers will be the world’s Mexicos or Cameroons.  These countries will be doubly punished: not only will they be unable to raise funds to deal with the crisis, but capital will also move away, as it has already started to, precisely because of the increase in borrowing by the US, China, and European countries.  

It is little wonder, then, that about 100 countries have already approached the International Monetary Fund for financial assistance. Fighting a global pandemic is all about strengthening the weakest links. Eradication of COVID-19 is a weakest link public good (Barrett 2006).

In response to this crisis, the Group of 20 leading economies agreed to a temporary debt service standstill on bilateral official loan repayments from a group of 76 of the poorest countries (the so-called IDA countries).^[4]  This is a positive first step, but the agreement needs to be extended along two dimensions. First, the exclusive focus on the poorest countries leaves out many low and middle income countries that already face severe economic strains. Second, a key constituency missing from the G20 plan is private creditors whose participation is sought only on a voluntary basis. Although they are not the most important creditors of IDA countries, they are crucial for middle income countries such as Mexico, where they hold the majority of the sovereign debt.

In the absence of private sector participation, official debt relief in middle income countries may partly be used to service private creditor claims. Given the expected size of the fiscal needs of these countries, any financial relief dissipated on debt servicing of private creditors claims will be very costly. Moreover, participation by private creditors cannot be wholly “voluntary”.  If participation is voluntary, relief provided by those private creditors that participate will simply subsidize the non-participants. And history teaches us that a significant number of private creditors will not volunteer to participate.  

In sum, for emerging and developing countries to be able to withstand the economic shock, it is imperative to include all private creditors as a part of a future debt standstill. We propose that multilateral institutions such as the World Bank or other multilateral development banks create a central credit facility allowing countries requesting temporary relief to deposit their stayed interest payments to official and private creditors for use for emergency funding to fight the pandemic. Principal amortizations occurring during that period would also be deferred, so that all debt servicing would be postponed.

The facility would be monitored by a multilateral lending institution to ensure that the payments that otherwise would have gone to creditors be used only for emergency funding related to the global pandemic. Our assumption is that all funding from this emergency facility and associated deferred principal payments would eventually be repaid by the country, and that investors would get their money after the crisis is over. We estimate that a 12 month debt standstill from both bilateral and private sector creditors would provide around $800 billion in resources for emerging and developing countries (ex-China), representing 4.7% of their annual income.

Domestic contract law regimes incorporate doctrines that allow the performance of a contract to be suspended (or occasionally avoided entirely) upon the occurrence of events that are wholly unforeseen, unpredictable and unavoidable. For its part, public international law recognizes, in a doctrine called “necessity”,  that states may sometimes need to respond to such exceptional circumstances even at the cost of suspending normal performance of their contractual or treaty undertakings.  COVID-19 meets all of the criteria for such an exceptional phenomenon.   Countries badly afflicted by this pandemic will need to deploy their available financial resources in immediate crisis amelioration measures. Those funds must be obtained from several sources—a diversion of budgetary amounts that had been earmarked for other purposes before the crisis, loans or grants from official sector institutions and a redirection of money that had been intended for scheduled debt service. In making these adjustments, the states concerned will not be acting in a discretionary or optional manner; in the truest sense of the word they will be acting out of necessity. We believe that everyone, and particularly the G-20 countries, should publicly acknowledge this fact in the context of recommending a standstill on debt service payments under bilateral and commercial credits for a limited period.

What is at Stake

In 2018 developing and emerging market countries (excluding China) had a stock of external debt of approximately $5.9 trillion. About 82% of this debt ($4.8 trillion) was classified as long-term (with original maturity greater than one year), with $2.1 trillion owed by the private sector and $2.7 trillion either owed to or guaranteed by the public sector. Of the public sector external debt, about 40% was owed to the official sector ($600 billion to multilateral creditors and $400 billion to bilateral) and the remaining 60% to private creditors (bonds amounted to $1.3 trillion and bank loans to $380 billion).^[5]

One way of estimating the effect of the COVID-19 crisis on the ability of emerging and developing countries to roll-over their external public debt is to assume that these countries will lose market access at least until the end of 2020.^[6] If official financing remains constant, net flows tied to long term debt with official creditors are expected to be $25 billion ($120b disbursements minus $71b principal repayment and $24b in interests) and net flows with private creditors amount to -$252 billion, as there will be principal and interest payments due ($170b and $82b, respectively) but no disbursements (which in 2018 amounted to $237b). Hence, the estimated shortfall on long term debt flows will be $227 billion. 

To this figure, we need to add short-term debt. We do not have detailed data on the share of short-term external debt owed by public sector borrowers, but it could be as high as $500 billion. Bringing the total shortfall to $735 billion (for details, see Table 1 in the Appendix). This total shortfall provides an estimate of the potential public sector sudden stop, while the total sudden stop would also include equity flows and lending to private debtors.

The recent G20 decision to grant debt relief to the poorest countries focuses on the bilateral debt of the group of countries which are eligible to borrow from the World Bank concessional window (the International Development, Association, IDA) plus Angola. The total shortfall for this group of countries (last column of Table 1 in the Appendix) is estimated at $36 billion. The principal and interest due by these countries to bilateral creditors (the focus of the G20 action) is $14 billion, less than 2% of our estimates for the public sector sudden stop associated with COVID-19 across all low and middle income countries. 

Figure 1 shows how this shortfall varies across geographical regions and income groups. The most affected region will be Latin America and the Caribbean, followed by Emerging Europe. For Emerging Europe about 50% of the sudden stop will be associated with the need to service and rollover long-term external debt and the remaining half related to short-term debt flows.^[7] For Latin America and the Caribbean about two-thirds of the sudden stop will be associated with short-term debt rollover needs.^[8]  The figure also shows that for middle income countries “business as usual” net-official inflows (which tend to be positive and hence have a negative value in our measure of shortfall) cannot be expected to compensate the expected sudden stop in bond and bank financing. The Figure also shows that the G20 debt relief of April 16, $14 billion, is very small compared to the total expected shortfall.

Figure 1: Potential public sector sudden stop

This figure plots the potential public sector sudden stop across geographical regions and borrowing groups. It assumes business as usual net flows from official creditors. The G20 Act. Bar plots the debt relief measure implemented by the Group of 20 on April 16, 2020.

As there is some uncertainty on the share of external short-term debt owed by the public sector, Figure 2 provides a detailed breakdown concentrating on the long-term component of this potential public sector sudden stop. In Emerging Europe, most of the potential public sector sudden stop on long-term debt (80%) is related to the need to rollover maturing bonds and loans, while in Latin America interest payments amount for more than 40% of financing needs (about the same as for the group of upper middle countries). 

Figure 2: Public sector external debt service (only long-term debt)

This figure plots the potential public sector debt service needs across geographical regions, borrowing groups, and creditor groups (Multilaterals, Bilaterals, Bond, Other Commercial Creditors). The dotted bars measure interest payments (Int.) and the solid bars repayment of principal (Princ.). The G20 Act. Bar plots the debt relief measure implemented by the Group of 20 on April 16, 2020.

Figures 3 plots country-specific estimates of the public sector sudden stop, expressed as a share of total government expenditures. There are 35 countries for which the public sector sudden stop will amount to more than 15% of government expenditures and 24 countries where the potential public sector sudden stop is greater than 20% of public expenditures.

Figure 3: Potential public sector sudden stop as a share of government expenditure

This figure plots the potential public sector sudden stop as a share of government expenditure for all countries where this share is larger than 1%, broken down into Official net flows (Off), Private creditors Interest Payments on long-term debt (Int.), Private creditors principal repayments on long-term debt (Princ.) and public sector short-term debt (ST). The dashed line plots the potential sudden stop including short-term debt and the solid line excludes short-term debt.  

We should interpret these figures with caution. On the one hand, they may overstate the problem since they assume a complete sudden stop in private sector financing. It is possible that not all short-term credit will collapse, and some countries may even be able to maintain access to long term debt. For instance, at the end of March, Panama managed to issue a $2.5 billion sovereign bond in the international debt market. Similarly, we may be overestimating the share of short-term debt owed by the public sector. On the other hand, these figures are likely to greatly understate the problem as they do not take into account funding gaps associated with: 

1. The collapse of international lending to the private sector (which accounts for 40% of total long-term external debt developing countries); 
2. The sudden stop in equity flows (both portfolio and FDI)
3. The currency depreciation which will increase the cost of serving foreign currency loans. 

An increase in official disbursement equal to all payments due to the official sector could close about 13%  of this shortfall ($71 billion in principal repayment and $24 billion in interests), but developing and emerging market countries will still need an additional $640 billion. One possibility would be to greatly scale-up official sector lending. Landers, Lee, and Morris (2020) estimate that the lending capacity of the multilateral development banks (MDBs) could increase by more than $1 trillion. 

Yet these figures assume a constant public sector expenditure and deficit. Hence they fail to recognize that the sudden stop comes while GDP in emerging and developing economies is expected to contract by 1% in 2020 (with contractions as large as 5% in Emerging Europe and Latin America) according to the April 2020 IMF World Economic Outlook projections, down from 3.7% output growth in 2019.  Lower economic activity will reduce tax revenues while government expenditures must increase to protect citizens and the economy. Overall, the IMF estimates that emerging economies’ funding needs will total $2.5 trillion, a figure that we find conservative.^[9]

Even a dramatic increase in MDB lending will not be sufficient and the private sector will have to be involved in offering relief. The G20 could enable a generalized private sector debt suspension by coordinating a stand-still that would apply to all sovereign-debt payments due by emerging and developing economies that requested such a freeze, and that would remain in place until the health crisis passes (Gourinchas and Hsieh, 2020). Such a standstill could free up to $803 billion  corresponding to 4.7% of the total GDP of emerging and developing countries.^[10]

The standstill may well bring private lending to the countries that request it to a full stop, but for all intents and purposes such capital flows have already stopped or even been reversed. Perhaps the standstill may lock these countries out of international capital markets for some time, but the stigma from the suspension on this occasion should be feared much less given that it is a necessity brought about by a worldwide pandemic rather than the result of fiscal profligacy. The official sector’s endorsement of the necessity of such a generalized standstill would also minimize any reputational or legal risk. A key issue, as always is how to get the entire private sector involved and how to limit free riding.

For purposes of our analysis, we put aside short-term claims that are typically governed by the domestic laws of the issuer and, therefore, more pliable (see Buchheit and Gulati 2019). Our focus instead is on external debt issued under foreign laws.  Here, a coordinated effort by the G-20 to apply a generalized standstill to all debt payments due by an emerging or developing country that requests such a pause in payments would go a long way in addressing this issue. Our proposal provides a concrete roadmap to achieve an effective coordinated debt relief between the official and commercial sectors.   

The Proposal

Mechanics.  Implementation of an emergency standstill, particularly for commercial creditors of middle income countries, presents a challenge.  Some countries will have dozens of external debt instruments with hundreds or even thousands of individual creditors.  Attempting a bespoke standstill negotiation for each of those instruments is impractical.  It would take many weeks or months at the very time when the debt relief is needed most critically.  No individual commercial creditor or group of creditors will be in a position to prescribe eligible uses for the money that would otherwise have gone toward debt service much less be in a position to monitor and verify how those funds are actually spent.  Individually negotiated amendments to existing debt instruments will inevitably produce a welter of incongruent conditions, financial terms, covenants and so forth, probably at ruinous legal expense.  Therefore, all creditors will be asked for the same relief — a standstill on interest payments for a prescribed period.  Since a bespoke implementation of that request will result in choppy, inconsistent outcomes among affected creditors, we suggest a streamlined approach as follows:

• The World Bank or the multilateral development bank for the region concerned would open a central credit facility (a “CCF”) for each country requesting this assistance.  The CCF would specify the eligible crisis amelioration uses for drawings under the facility, as well as the arrangements for monitoring the use of proceeds.
• In view of the nature of this emergency, each CCF should have terms (interest rate and amortization) that will not aggravate the post-COVID-19 financial position of the beneficiary country.
• Once a CCF is in place for a country seeking this assistance, the debtor country would notify each of its bilateral and commercial creditors that interest payments on existing debt instruments falling due during the prescribed standstill period will be directed to (and reinvested in) the CCF.  Each lender would also receive a formal request from the debtor country seeking the lender’s acknowledgment that the reinvestment of the interest payment into the CCF (and the crediting to the lender’s account of a corresponding interest in the CCF) will constitute a full discharge and release of the borrower’s obligation in respect of the relevant interest payment.^[11]  For indebtedness in the form of international bonds, this acknowledgment will probably be sought through a consent solicitation addressed to all holders of each such bond.
• The threshold decision about whether to seek a standstill on interest payments for a limited period will, of course, rest in the discretion of each sovereign debtor. Some countries may be spared the worst of the pandemic and will not need this relief while others may continue to enjoy market access during this period and would not wish to jeopardize that status by deferring current interest payments. 

Principal amortizations.  Participating countries with principal amortizations falling due during the standstill period will need to defer those amounts.  It would obviously be inconsistent to seek a standstill on interest amounts while simultaneously paying principal.  Such deferral could be handled in one of several ways.  The official sector might encourage, perhaps even insist, that all participating countries with principal payments falling due during the standstill period enter into more or less simultaneous exchange offers at the beginning of the process to reschedule those principal amounts.  This would address the issue in a coordinated and possibly uniform manner at the outset.  Alternatively, some creditors may prefer voluntarily to reinvest their principal payments into the CCF, thereby taking advantage of both the de facto seniority of the CCF and the automatic monitoring of proceeds embedded in the CCF.  The other option would involve negotiating deferrals of principal payments on a case-by-case basis.  Only a subset of participating countries will have principal maturing during the standstill. The important task is to effect a deferral of those amounts so that they do not result in a diversion of funds intended for crisis amelioration measures.  The precise manner in which that objective is accomplished can be left to the debtor countries and the affected creditors.

Sustainability considerations.  Some countries will have had unsustainable debt positions before the COVID-19 crisis hit, others will have unsustainable debt positions after the crisis abates.  A standstill on interest payments for the balance of 2020 or slightly longer does not preclude or prejudge a more durable debt restructuring for one of these countries at the appropriate time.  A CCF, in light of its origin and purpose, ought to be considered a de facto senior instrument in such a debt restructuring, the equivalent of debtor-in-possession financing in a corporate insolvency.  Because the aggregate amounts redeployed through a CCF should for any given country be small (equal to interest accruals for +/- 12 months), the effect of such a recognition of seniority in a general debt restructuring should be negligible.^[12]

Necessity.  We perceive little political enthusiasm for a resurrection of proposals for an institutionalized sovereign bankruptcy regime, nor is there any time to design and implement such a regime in the middle of this crisis.  There is one measure, however, that the official sector could take that may assist debtor countries if legal challenges are raised by minority creditors to these arrangements.  In any public statement about these measures and the global emergency that gave rise to the measures, the G-20 could recognize that both official sector institutions and the debtor countries are acting out of necessity, referencing Article 25(1) of the Articles on State Responsibility promulgated by the International Law Commission in 2001.^[13]

Advantages.  Implementing a standstill on interest payments for a prescribed period through these arrangements would have the following advantages:

• All participating creditors in each country (bilateral and commercial) would be treated equally.  All would receive an identical instrument (an interest in that country’s CCF) corresponding to the amount of their reinvested interest payments. 
• All issues related to the identification of eligible crisis amelioration expenditures, conditions precedent to drawdowns and post-disbursement monitoring would be centralized in the CCF and administered by a multilateral institution.
• Amounts reinvested in a CCF would stand the best chance of being repaid even if the debtor country concerned eventually needs a full-scale debt restructuring.
• These arrangements can be implemented immediately after a CCF for the debtor country can be put in place, a feature that will be of critical importance as this crisis rages.

Motivation

There are two parts to the proposal. The first concerns the reinvestment of payments due into a central credit facility for the recipient country administered by a multilateral development bank or the World Bank. 

This is an expedient solution to quickly administer the redirection of interest payments towards more urgent needs in poor countries that are already faced with the dire consequences of the global COVID-19 health and economic crisis. This is the primary motivation for setting up such a facility. Moreover, it would make it easier to monitor the use of funds and to keep a record of all the interest payments that have been redirected in this way. 

The urgent problem is to give recipient countries immediate and comprehensive debt relief. To insist on these countries first getting consent of their creditors will introduce unnecessary and costly delay. It would largely defeat the purpose of providing debt relief. 

The first step of our proposal is for the recipient country to set up a CCF with an MDB and agree to a list of eligible expenditures as well as a timeline for the later repayment of the frozen debt obligations. Once the facility is in place all the sovereign debtor would be required to do is notify its commercial and bilateral creditors that the payments due have been paid into the CCF and that the custodian of the CCF has been instructed to record an interest in the CCF in the name of the creditor. At that point the affected creditor would simply acknowledge and agree that the crediting of the CCF in this manner constitutes a full discharge and release of the debtor’s obligation in respect of the debt obligation concerned. 

This procedure has several practical advantages. First and foremost it can be implemented quickly, essentially immediately upon activation of the CCF. Second, while the underlying debt instrument may be in technical default during the period between the diversion of the interest payment into the CCF and the receipt of the creditor’s consent to this action, that default should be of limited duration and may, depending on the terms of the debt instrument, be covered by the relevant grace period. Even if the commercial creditor were affirmatively to refuse to give an acknowledgment of discharge and release, the creditor’s resulting damages would be offset in large part by the value of that creditor’s corresponding interest in the CCF.  Third, by treating all creditors equally, the CCF in effect assures intercreditor equity. Fourth, by limiting the debt relief to a temporary suspension of debt payments, and by protecting interest payments from misappropriation through the channeling of payments into the CCF, one can reasonably expect that few creditors will choose to opt out and seek legal remedy. The reputational cost to such holdout creditors, acting against the common interest in times of exigency, would not be worth the benefit of receiving full payment of the temporarily suspended interest and principal payments.  

The second part of our proposal concerns our call to the official sector to provide some cover to debtor countries, which could face legal challenges from holdout creditors, by publicly stating the purpose of the debt relief, namely the necessary relief from debt obligations to help debtor countries face the global emergency engendered by the COVID-19 pandemic. By recognizing that the official sector creditors and the debtor countries are acting out of necessity, the G-20 would play an important certification role of the extreme and exigent circumstances they are facing. Depending on the law of the jurisdiction where a holdout creditor may elect to pursue its legal remedies, such a public statement by the G-20 may assist the sovereign debtor in defending its action as the minimally necessary to respond to the exigent circumstances of the pandemic.  

Past economic crises, whether in the US or elsewhere, have sometimes led to political interventions to suspend debt payments or to make other modifications to the terms of debt contracts. Such interventions may be necessary and do not automatically undermine credit markets. In some instances they have actually had the opposite effect, resurrecting debt markets following the intervention. The reason why debt markets recovered was that creditors had anticipated widespread default in the absence of any modification of the repayment terms, and they were pleasantly surprised by the intervention that had the effect of reducing the risk of default.^[14] Creditors on average preferred the certainty of receiving a reduced repayment to the very uncertain prospect of being made whole.   

To be sure, creditors generally do not expect that the promised repayment of their debt contracts will always be honored. They understand that there could be circumstances when it would be essentially impossible for the debtor to meet its obligations. Had they been able to clearly and precisely anticipate these circumstances they would have modified the terms of the contract to reflect these necessities and thereby avoided a wasteful and unnecessary default. 

For many reasons most debt contracts are highly incomplete and do not contain provisions prescribing how the parties will react to such contingencies. To name just one, it is very difficult to specify precisely in advance the exact form of a contingency such as a global pandemic that would merit lowering debt obligations in this event. Ex post it is easier, of course, to identify the contingency. The political intervention in debt contracts in these events serves the role of completing incomplete debt contracts. By certifying the event and by modifying the terms of the debt contract in ways that the contracting parties themselves would have wanted had they been able to, the intervention, far from undermining credit markets, helps support these markets.^[15]           

Not all interventions are beneficial in this way. It is important that they take place only in highly unusual and urgent circumstances that are outside the debtor’s control (“acts of God”). Unusual circumstances are precisely the ones that are hard to describe and include in a debt contract. By certifying that such an event has occurred and by acting accordingly, the G-20 would ensure that contract terms will be modified only when absolutely necessary and when the modifications are likely to support credit markets.^[16]  

To summarize, debt suspension in a crisis provides ex-post economic benefits by avoiding a costly default and by relaxing the liquidity constraint of debtors. These ex-post economic benefits do not negatively affect credit markets ex ante even when suspension in rare circumstances is anticipated. The reason is that the contracting parties themselves would have included lower debt obligations in these circumstances. It is the inability of the contracting parties to describe these circumstances ahead of time that explains the incompleteness of the debt contract. But the contracts can be completed through political intervention in times of exigency.   

Endnotes

^[1] The $2.3 trillion dollar rescue package in the US is 10.6% of US GDP in 2019 (https://www.bea.gov/news/2020/gross-domestic-product-fourth-quarter-and-year-2019-advance-estimate)

^[2] See IMF 2020,  Fiscal Monitor April 2020, Figure 1.1

^[3] https://www.iif.com/Publications/ID/3829/IIF-Capital-Flows-Tracker-The-COVID-19-Cliff

^[4] The group of countries targeted by the G20 also includes Angola, which is not an IDA country but it is classified as a Least Developed Country by the United Nations. 

^[5] Table A1 in the appendix provides a detailed breakdown. These values exclude IMF credit that in 2018 amounted to approximately $155 million. There are several caveats with the data reported here which are based on the World Bank’s International Debt Statistics (IDS). First, IDS may not include all the domestically issued bonds which are held by non-residents (and hence should be classified as external debt). For instance, Arslanalp and Tsuda (2014) track the ownership of central government bonds owned by non-residents in a group of 15 large emerging market countries and for many countries report values that are much larger than the values reported by IDS. Arslanalp and Tsuda (2014) also report larger share of local currency bonds owned by non-residents). For a detailed discussion of this issue see Panizza (2008) and Panizza and Taddei (2020). Second, IDS do not report detailed information on the breakdown of short-term debt (debt with initial maturity below one year). Therefore, we need to make some assumption to allocate some of his debt to the public sector (details are in the notes to Table A1). Third, Horn, Reinhart, and Trebesch (2019) suggest that only part of Chinese overseas lending is reported in the IDS. If we assume that only 50% of Chinese loans are reported in the IDS, the total stock of debt of developing and emerging market countries would increase by approximately $200 million. While this is less than 4% of total debt for the whole group of developing and emerging market countries, under-reporting linked to Chinese loans could be as high as 10% of the total debt of low income countries. Finally, IDS data do not report the amounts of World Bank borrowers which are now classified as high-income (for instance, Chile). 

^[6]As data on roll-over needs for 2020 are not available, we follow Gourinchas and Hsieh (2020) and use 2018 as a proxy. Interest payments for 2020 (which are reported by IDS) closely track interest payments for 2018. Hence, we assume that the composition of level of debt for 2020 is similar to that of 2018.

^[7] Short-term debt is classified on the basis of original maturity.

^[8] Note that we do not net out Argentina’s debt which is already in default.

^[9] https://www.imf.org/en/News/Articles/2020/03/27/tr032720-transcript-press-briefing-kristalina-georgieva-following-imfc-conference-call

^[10] This Figure includes principal and interest due to private creditors ($252 billion in long-term debt and $508 billion of estimated short-term debt) and principal and interest due to bilateral official creditors ($43 billion). It does not include $53 billion due to the multilateral development banks which are in the process of greatly scaling up their lending to emerging and developing countries to counteract the private sector sudden stop.

^[11] Communications addressed to creditors with an implicit “No RSVP Necessary” message have a long tradition in sovereign debt workouts. See Buchheit (1991). When the United Mexican States announced its moratorium on external debt payments in August of 1982 (generally thought to be the opening act in the Latin American debt crisis of the 1980s), the commercial bank lenders received a telex from Mexico asking them to roll over maturing principal amounts of their loans pending an eventual restructuring of those loans. The lenders were not asked to respond to the request. And any responses that did arrive declining the request and insisting on timely payment of maturing principal were simply ignored.

^[12] The de facto seniority of amounts lent through the CCF could be further enhanced by contributing to the CCF some amount of money (it really doesn’t matter how much) from an institution like the World Bank or a multilateral development bank that enjoys a widely-recognized preferred creditor status. As long as those funds are thoroughly commingled with other amounts in the CCF, the sovereign debtor could not default on payments due under the CCF without thereby placing itself in default to a recognized preferred creditor. Such an outcome would risk alienating the affections, and the funding, of all official sector institutions. A similar “co-financing” technique was used in the Greek debt restructuring of 2012 where amounts owed to commercial creditors were contractually linked to amounts due to official European agencies such as the European Stability Mechanism. See Zettelmeyer et al. (2013).  For a description of the development of the co-financing technique during the sovereign debt crises of the 1980s see Buchheit (1988). For an analysis of how debtor-in-possession financing could work in a sovereign debt context see Bolton and Skeel (2005).   

^[13] Article 25(1) Necessity: 

Necessity may not be invoked by a State as a ground for precluding the wrongfulness of an act not in conformity with an international obligation of that State unless the act: 

(a) is the only way for the State to safeguard an essential interest against a grave and imminent peril; and 

(b) does not seriously impair an essential interest of the State or States towards which the obligation exists, or of the international community as a whole. 

International Law Commission (2001).

^[14] See Kroszner (2003) and Edwards, Longstaff, and Marin (2015) on the positive effect on debt markets of the repudiation of the gold indexation clause in debt contracts during the Great Depression.

^[15]See Bolton and Rosenthal (2002) for an analysis of how ex post political intervention in debt contracts can be seen as a way of completing incomplete debt contracts.

^[16]Moral hazard and the concern that the doctrine of necessity will be liberally applied to future events should be allayed by the fact that COVID-19 is a truly exogenous once-in a generation event. The latter point is supported by the following facts: (i) official forecasts point to the deepest global recession since the Great Depression; (ii) global lockdown policies which are more stringent than those adopted during World War II; (iii) unprecedented monetary and fiscal policies adopted by all advanced economies and several emerging market countries.  

Appendix

Table 1: Baseline data by country groups

This table reports debt stocks, disbursements, principal repayments, and interest due by type of debt and creditor group for all developing and emerging market countries excluding China. The regional and income classification are those adopted by the World Bank (EAP: East Asia and Pacific; ECA: Emerging Europe; LAC: Latin America and the Caribbean; MNA: Middle East and North Africa; SAS: South Asia; SSA: Sub Saharan Africa; LIC: Low-income countries; LMIC: Lower-middle-income countries, UMIC: Upper-middle-income countries). The last column (G20 Action) includes all countries targeted by the debt-relief action decided by the Group of Twenty on April 16, 2020.

References

Arslanalp, Serkan and Takahiro Tsuda (2014) “Tracking Global Demand for Emerging Market Sovereign Debt,” IMF Working Paper 14/39.

Barrett, Scott (2006) “The Smallpox Eradication Game,” Public Choice 130:179–207.

Bolton, Patrick and Howard Rosenthal (2002) “Political Intervention in Debt Contracts,” Journal of Political Economy 110:1103-34.

Bolton, Patrick and David A. Skeel (2005) “Redesigning the International Lender of Last Resort,” Chicago Journal of International Law 6(1): 177-201.

Buchheit, Lee C. (1991) “Debt Restructuring-Speak: ‘¿Senor, Que Pasa?’,” International Financial Law Review, March, 10-11.

Buchheit, Lee C. (1988) “Alternative Techniques in Sovereign Debt Restructuring,” University of Illinois Law Review 1988: 371-399.

Buchheit, Lee C. and Mitu Gulati (2018) “Use of the Local Law Advantage in the Restructuring of European Sovereign Bonds,” University of Bologna Law Review 3(2): 172-179.

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The post Born Out of Necessity: A Debt Standstill for COVID-19 appeared first on Economics for Inclusive Prosperity.

We provide an overview of the policies that could form a comprehensive social protection strategy in developing countries, with examples of specific policies adopted around the developing world in recent days. Our core argument is that middle-income and lower-income countries can cast an emergency safety net with extensive coverage if they use a broader patchwork of solutions than higher-income countries. These strategies could include:

1. Expanding their social insurance system, which typically covers a much smaller share of the labour force than in higher-income countries;
2. Building on existing social assistance programmes, which reach a large share of households in many developing countries;
3. Involving local governments and non-state institutions to identify and assist vulnerable groups who may not be reached by 1) and 2).

The debate on social protection responses occurs as countries face both a public health and a public finance crisis. First, governments have to design a public health response to mitigate or suppress the virus, which balances provision of COVID19 health care against other health needs, and which can be implemented in contexts where strict social distancing is not practical.^[5] The strictness and duration of the restrictions imposed on mobility and economic activity will, to a large extent, determine the immediate impact on household incomes, and thus the scale of the social protection response needed to mitigate it. In turn, the support provided to help households could increase compliance with public health policies.^[6] Second, governments have to finance both health and economic measures, while experiencing shortfalls in tax revenues. Many developing countries were already heavily indebted before the crisis, and investors have sold emerging market assets, making borrowing on the open market difficult.^[7] Without novel solutions to allow governments to borrow internationally and secure additional aid quickly,^[8] the scale of their social protection response will be limited, and developing countries may not afford a public health response imposing strict restrictions on their economies.^[9]

Key features of developing countries^[10]

Low-income and middle-income countries share features that present specific challenges and opportunities for their social protection response, compared to higher-income countries.^[11]

1. The economic consequences of the crisis for households in developing countries will be severe. A larger share of workers are in occupations and industries less compatible with social distancing (e.g. construction, labour-intensive manufacturing, small retail). Households have more limited access to credit and hold limited savings or buffer stock. Their usual means of smoothing income shocks, casual work and migration, are not possible when economic activity and mobility are restricted. Support from social networks is also more limited when everyone experiences a simultaneous shock, which in the case of a global crisis is true even of the most extended networks (e.g. international remittances). Complying with public health guidelines will incur out-of-pocket costs (e.g. access to water in urban slums) that are high as a portion of available income. In this context, households may take short-term decisions out of necessity that leave them in long-term poverty, such as selling assets to finance food consumption. Moreover, firms often face more severe liquidity constraints in developing countries, limiting their ability to keep paying their workers during the crisis. The need for government intervention is thus particularly severe in developing countries today.
2. Yet, government programmes insuring against job or earnings loss have more limited scope in developing countries. First, a larger share of workers are in employment categories that are difficult to insure against such risks. Many employees work for informal (i.e. unregistered) businesses, which may not contribute to existing social insurance programmes, while others work for formal businesses on informal contracts. The self-employed — whose “regular” income is more difficult to assess even in richer countries – account for a larger share of employment, and many of them also carry out their activities informally. Second, government programmes insuring workers against such risks are more limited in developing countries even for formal (i.e. registered) employees. For instance, the share of developing countries in which these workers are eligible for some form of Unemployment Insurance is much lower than in higher-income countries (see Figure 1). Existing social insurance programmes will thus be less effective in supporting workers in developing countries.

Figure 1: Share of countries with unemployment Insurance

3. At the same time, many developing countries can build on large existing social assistance programmes. As Figure 2a shows, these cover a sizable share of the population, including contexts where informal work and self-employment are the norm. These programmes take various forms, such as conditional or unconditional cash transfers, work guarantees, or the direct delivery of food and other necessities (see Figure 2b). They target poor households and are not necessarily designed to mitigate job loss or income shocks. They can be made more generous in this time of crisis. They can also provide a base for emergency assistance, e.g. they often rely on detailed registries and effective infrastructure for transferring resources. Existing social assistance programmes thus provide invaluable mechanisms to provide emergency relief to many households.

Figure 2: Social assistance programs in developing countries

Source: ASPIRE (World Bank); data collected between 2008-2016 http://datatopics.worldbank.org/aspire/

4. Some vulnerable populations are not easily covered by social insurance and are usually outside the populations targeted by social assistance programmes (e.g. informal workers with volatile incomes, migrant workers), making them particularly hard to reach in an emergency. However, local governments in many developing countries are in a good position to assess unmet needs and to deliver direct assistance. The same is true of a range of non-state actors (e.g. NGOs, savings and loan associations, mutual insurance organisations), which are active in contexts where state capacity is limited (e.g. remote rural areas or urban slums). Involving local actors, especially non-state ones, is an opportunity but also a challenge, as their efforts need to be coordinated, and they need to be monitored by both citizens and national governments. Credible partners thus exist for central governments to help “harder-to-reach” segments of the population, as long as their actions are in line with the national effort and are accountable to the public they serve.

Expanding the social insurance system

Despite pervasive informality, formal employees constitute a major employment category in many developing countries, particularly in middle-income countries. Moreover, these workers are possibly even less well prepared than their counterparts in richer countries to cope with the economic impact of the crisis. Therefore, expanding the social insurance system to provide more support to formal employees could be an important pillar of the social protection strategy of developing countries, even if it will not be sufficient to reach all workers (e.g. informal workers).

Governments around the world have adopted new job retention schemes in the last few weeks. Such schemes already existed in some countries (e.g. Germany, Italy), including developing countries (e.g. Brazil), to help firms cope with temporary shocks (e.g. drop in demand, insolvency issues, natural disasters). They provide subsidies for temporary reductions in the number of hours worked, replacing a share of the earnings forgone by the worker due to the hours not worked, over a maximum period of time (a few weeks or months). Their advantage in the current crisis is to avoid the destruction of existing jobs (Giupponi and Landais, 2018), which should be viable again once the public health response is relaxed. Subsidizing these jobs could allow firms to continue to operate, even if at some reduced level, without imposing large pay cuts. Subsidizing the survival of jobs that must be temporarily suspended could also spare workers and firms the costs of finding a new job and replacing the worker, speeding up the economic recovery.

The argument in favor of job retention schemes is strong for developing countries. Without such schemes, many workers will be laid off with no unemployment insurance. Moreover, setting up a new job retention scheme might be logistically easier than setting up an unemployment insurance programme, as governments could use firms as intermediaries to channel the income support to their workers. Job retention schemes are also most valuable in labour markets where search frictions are high. Recent research shows (i) that finding the right workers is a major challenge to firm growth in developing countries (Hardy and McCasland, 2017); (ii) that workers struggle to find formal employment because of difficulties signalling their skills credibly to firms (Abebe et al., 2020, Carranza et al., 2020); (iii) and that displaced formal employees take much longer to find a new formal job than in higher-income countries (Gerard and Gonzaga, 2016). The destruction of existing jobs might thus have severe longer-term impacts on the size and productivity of developing countries’ formal sectors, which are a key policy focus (Levy, 2008).

Some implementation details might be particularly important in developing countries:^[12]

• Targeting. In Thailand, a recent job retention scheme covers a fixed share of workers’ monthly earnings;^[13] in Morocco, a new programme provides a fixed monthly amount to workers whose job must be temporarily suspended;^[14] the amount received under the Brazilian and South African schemes is not fixed but the share of forgone earnings that it replaces is lower for higher-wage workers.^[15] Targeting the income support to low-wage workers can help more workers for a given budget and leave more financial resources to help other worker categories. However, it will require higher-wage workers to make relatively larger adjustments and increase the risk that their jobs will not survive the crisis. Additionally, targeting support to low-wage workers may not necessarily target jobs for which search frictions are most important, which may slow down the economic recovery.
• Payment. In contrast to some pre-existing job retention schemes (e.g. in France), the above-mentioned schemes do not rely on firms advancing the payment of the earnings subsidy. Firms in developing countries may not have enough liquidity to make such advances or may not trust the government to reimburse them quickly, disincentivizing participation (see Levinsohn et al., 2014, on an earlier wage subsidy in South Africa).
• Other firm contributions. Job retention schemes sometimes require firms to contribute towards their workers’ compensation beyond the hours actually worked (e.g. for larger firms in the Brazil scheme). This could incentivize firms struggling to stay afloat to lay off their workers rather than to participate in the scheme. More generally, firms face other costs than their payroll and helping them cover these costs might be necessary for existing jobs to survive. Several countries have implemented a range of policies in this regard, such as low-interest loans, rent moratoriums, or tax relief.^[16]

Even with a job retention scheme, many workers will likely be laid off and developing countries with unemployment insurance programmes will be in a better place to support these workers. However, it might be important to adjust their programmes, such as by relaxing job search requirements and extending eligibility rules. For instance, in South Africa, workers are usually eligible for one day of unemployment insurance for every six days of employment. In Brazil, many workers must accumulate up to 12 months of employment to become eligible for any benefits. Such rules could leave laid-off workers who have limited job tenure (e.g. less than a year) with little income support throughout this crisis and no other employment options in the short run.

A policy that is more common than unemployment insurance in developing countries are mandatory severance payments that firms must pay to workers at layoff. The insurance value of such lump-sum payments is limited when workers cannot find new jobs quickly. Moreover, firms facing severe reductions in cash-flow might struggle to pay what they owe to their workers and governments may need to provide firms with low-interest loans to fund severance pay obligations. Governments could also consider topping up the severance amount and spreading its payment over time to avoid workers spending it too quickly after layoff (Gerard and Naritomi, 2019).

Another common component of the social insurance system in developing countries are mandatory contributions by firms or workers to forced (illiquid) savings accounts for long-term objectives, e.g. to fund a complementary severance payment at layoff or a complementary pension at retirement. Workers could be allowed to withdraw some amount from these accounts in the current crisis. For instance, the Indian government recently allowed formal workers to withdraw up to three months worth of salary (but no more than 75% of the amount in the account) from their Employee Provident Fund.^[17] The benefits for workers from such early withdrawals might greatly exceed their costs, particularly for younger workers who will be able to replenish their forced savings accounts in coming years.

Finally, some countries have considered extending the logic of these social insurance programmes to formal (i.e. registered) self-employed workers. However, it is more challenging to determine (a) their “usual” earnings level prior to the crisis and (b) the reduction in earnings caused by the crisis. These challenges will only be exacerbated in developing countries, as governments likely have less information about these workers’ past or current earnings than in higher-income countries, even for self-employed workers who are formally registered.^[18] In this context, developing country governments may be left with fewer options:

• One option is to make unconditional monthly transfers of a fixed amount. For instance, the Auxilio Emergencial in Brazil will provide self-employed workers with a monthly payment of 60% of the minimum wage for the next three months.^[19] It might be possible to design a more fine-grained payment scheme, e.g. based on some presumptive income varying across sectors of activity. However, the costs of designing a more complicated scheme might outweigh its benefits if it leads to long delays in disbursements (as in the UK^[20]).
• A complementary option is to provide emergency low-interest credit lines for self-employed workers, allowing them to borrow a maximum amount to pay themselves in the coming months. Such policies have been recently implemented in some countries to help small and medium firms pay their workers’ wages throughout the crisis,^[21] and could be extended to self-employed workers. Repayment of loans could be made contingent on self-employed workers’ future income or gross revenue crossing above a certain threshold, to mitigate concerns of taking on more debt at this time.

Building on existing social assistance programmes

Social insurance programmes will fail to reach a large share of households in developing countries, in particular those mostly active in the informal sector of the economy. However, many of these households could be reached through social assistance programmes. For example, South Africa’s child support grant reaches many poor households who are in informal jobs and will not be covered by its job retention scheme.^[22] Maintaining these programmes throughout the crisis will already provide some minimal support to many affected households, although some of their rules might need to be adapted. These programmes could also be made temporarily more generous to compensate current beneficiaires for income losses. Finally, these programmes could be temporarily extended to new households, e.g. to households whose information was collected to target these programmes, and who were deemed ineligible. In practice, these programmes take many forms and their key features determine how they can be used in response to the crisis.

The first feature is the type of assistance that these programmes provide. Some programmes dispense cash; some provide in-kind assistance (e.g. food, fuel); others subsidize access to essential goods and services (e.g. health services, housing). In cases where supply chains are impacted or prices rise, in-kind provision will be most powerful, and public procurement will support producers as well. For instance, the Indian government doubled the monthly foodgrain (wheat and rice) household allowance and added pulses to the ration provided by the Public Distribution System.^[23] When households can buy goods and services at reasonable prices, cash transfers are quicker to implement and more fungible than in-kind transfers. Many countries have temporarily topped up the amount received by the current beneficiaries of social assistance programmes. For instance, the Indonesian government increased both the benefit amounts of its cash transfer programme (PKH) and the frequency of its payments (from quarterly to monthly).^[24] Kenya has increased the amount of its pension and orphan and vulnerable children’s grant.^[25] Finally, in the case of subsidies, the government can offer free provision or delay payments, especially for utilities that are publicly owned (e.g. electricity bills or rents). Indonesia has recently granted three months of free electricity to 24 million customers with low power connections.

The second feature is the conditionality of the social assistance. Conditional Cash Transfers (CCT) programmes are a popular form of income support in developing countries (e.g. Mexico’s Prospera or Brazil’s Bolsa Familia). They make assistance conditional on a particular behaviour encouraged by the state, e.g. enrolling children at school or immunizing them. Public works programmes are also often used for anti-poverty relief in the developing world (e.g. India’s MG-NREGS or Ethiopia’s PSNP). These conditions cannot be fulfilled at the time when countries have closed schools and public works sites because of safety, or when hospitals are overwhelmed. To provide social protection in the current crisis, CCT and public works programmes need to become temporarily unconditional. Removing conditionalities may be legally or politically difficult. For instance, India’s relief package increases the wage for MG-NREGS workers, but it makes no provision to make public work sites compatible with social distancing. Other public works programmes, such as  Ethiopia’s PSNP (Berhane et al., 2015), already provide cash or food for those identified by communities as unable to work and could perhaps extend this feature to all programme recipients.

The third feature of social assistance programmes is the population that they target. Some programmes help specific socio-demographic groups (e.g. non-contributory social pensions for the elderly or grants for orphans and children). Some provide relief to specific occupational groups (e.g. farmer drought relief funds). Others are targeted according to economic indicators, such as transfer to households deemed poor based on their assets (e.g. Indonesia’s conditional cash transfer PKH). Developing countries can leverage all their programmes simultaneously to provide assistance to a wide range of vulnerable groups. Each of these programmes suffers from inclusion errors, with resources being diverted to non-eligible households or stolen by corrupt bureaucrats, and from exclusion errors, with eligible households deterred from applying (Hanna and Olken, 2018). In these times of emergency, governments will have to rely on social assistance programmes, even if their targeting is not perfect. Direct beneficiary payments, and transparency in how much is given to whom, may help keep “fund leakages’’ under control (Muralidharan et al., 2016; Banerjee et al., 2018).

Using existing programmes to extend assistance to new beneficiaries is possible, but requires both information on potential beneficiaries and payment infrastructure to reach them. Some countries have built digital infrastructures linking governments and poor citizens for various programmes that can now be used for emergency payments (see Rutkowski et al., 2020). For example, Chile has a national ID-linked basic account for most poor people, which will be used to pay more than 2 million low-income individuals a once-off grant. India also has sent money to Jan Dhan accounts linked to the Adhaar ID system, which were created to promote financial inclusion among the poor. Other countries have detailed censuses to identify the poorest citizens for social assistance. These censuses can now be used to extend assistance to people who were initially deemed too well-off for assistance. For example, the Peruvian programme Bono Yo Me Quedo en Casa^[26] offers an additional transfer equivalent to 50% of the minimum wage to 2.7 million poor households identified in a dataset created to target the Peruvian Juntos CCT. Beneficiaries can check their availability online, and payments are routed via a national bank. In countries in which no pre-existing databases are available, or where governments would not automatically enrol large parts of the population in emergency assistance programmes, they may prefer to ask people in need of assistance to opt in. For instance, Pakistan has announced a relief package with large transfers to the poor, but the emergency programme requires people to self-identify as vulnerable and to text the existing social programme Ehsass with their national identification number.

Enrolling new beneficiaries and paying them is a challenge in many settings. In non-crisis times, enrolling people and checking eligibility may be more effective to target the poorest than automatic enrolment (Atalas et al., 2016). But enrolment systems set up in times of emergency may not necessarily target the most vulnerable efficiently.^[27] For instance, the state of Bihar in India has announced a transfer to all migrant workers stranded in other states and plans to perform identity checks through a phone app.^[28] Households recorded in the Cadastro Unico — i.e. the Brazilian census of the poor — will be eligible for the same Auxilio Emergencial as formal self-employed workers (see above), but the government also created a new website to extend coverage of this emergency assistance programme to informal workers at large. The use of these technologies may prevent individuals without a computer or smartphone from enrolling, unless complementary systems are set up. Even if they successfully enrol, transferring money to these new beneficiaries can be difficult. Relying on digital payment infrastructures is quicker and safer in an epidemic, but it might exclude particularly vulnerable households: globally, only 69% of adults have any digital bank or mobile money account; only 30% have received wages or government transfer payments directly to an account (Findex, 2017). In this context, it will be necessary to set up physical collection points or direct delivery systems for these households while still respecting social distancing measures. In Peru, bank branches were overcrowded when recipients of the Bono Yo Me Quedo en Casa programme came to cash their benefits.^[29]

Involving local governments and non-state institutions

A strategy based on expanding social insurance and building on existing social assistance programmes will likely leave important needs unmet. For instance, informal workers with volatile incomes (especially in urban areas) or with weak ties to their place of residence (e.g. migrant workers) are often beyond the reach of social insurance and usually outside the populations targeted by social assistance. A comprehensive social protection response could involve local governments and a range of non-state actors to collect better information on these unmet needs and to deliver targeted assistance.

State and municipal governments may play a complementary role to national governments, who often have the main mandate for social insurance and assistance. Many developing countries have decentralised extensively over the last decades, and have devolved a range of government functions to lower echelons of government, including responsibilities  related to social assistance. For example, the responsibility for implementing India’s employment guarantee MG-NREGS is devolved from the central government to the state, the district, the block, down to the Gram Panchayat, a local government of about 500 households. It is common for developing countries to elect or select a large cadre of leaders at very local levels. In Kenya, each village of ~120-200 households has a volunteer village leader who reports to the lowest level of paid civil servant, the assistant chief, adjudicates disputes and spreads information from the state (Orkin and Walker, 2020, Walker, 2019).

These structures can play multiple roles during this crisis. First, local structures can channel information up to decision-making structures, which is important when travel is limited. Information could be movements of people, price and availability of food, whether new social protection measures have been successfully implemented, and whether specific groups remain unexpectedly not covered. In food-insecure countries like Malawi and Ethiopia, infrastructure has been built to collect local data on food security and channel food or cash to famine-affected areas^[30] and public works programmes to food-insecure areas (Berhane et al., 2015, Beegle et al., 2017). Similarly, for public health success against ebola, it was vital that local structures relayed data back to co-ordinating structures for better decisions.^[31]

Second, local structures could be involved in the identification of individuals in dire need of additional support. They were often involved in the targeting of social assistance programmes pre-crisis, both in the gathering of information on vulnerable populations for higher levels of government and in the prioritization of assistance to the most needed.  For example, censuses of the poor used to target CCT programmes are typically updated by local administrations in Latin American countries. Rwanda is using local structures to target in-kind food security packages, which will complement its existing social protection scheme. Vulnerable households are identified at the most local (isibo) level, with information on numbers of households relayed up to higher government structures.^[32] To avoid exclusion errors, the capital city government set up a toll free line for households who reported they missed out in the targeting.^[33]

These institutions have particular strengths that may complement a national government response. They may have funding or staff already in place at local level. Local authorities often receive block grant funding to address locally identified needs, with local structures in place to monitor how it is allocated. Funding could be temporarily repurposed or these structures could be used to channel any additional funds granted. For example, the Indian government allowed state governments to use disaster funds to provide shelter and food to migrants workers.^[34] Local governments also have networks of employees (e.g. for education, health, welfare) in contact with more remote communities and able to support them in accessing services. For example, South Africa’s network of early childhood community care givers primarily conduct health promotion and prevention activities; pre-crisis, government tapped this network to assist families in enrolling for child support grants (Hatipoğlu et al., 2018).

Local governments often have better information on local needs and preferences, so may be more responsive. As a result, their decisions may have more legitimacy.  For example, in Indonesia, leaders allocating cash transfer benefits via community targeting did reasonably well in terms of targeting the poor. Communities were also more satisfied with community targeting than an externally administered proxy means test (Atalas et al., 2012). They may also be more easily held accountable to communities and may feel pressure to be more responsive, provided the resources and functions devolved to them are clearly communicated to the public (Gadenne, 2017, Martinez, 2018). For example, the state government of Bihar (India) has felt pressure to extend its attention to migrants in this crisis, a segment of the population which it does not usually serve or respond to, and which was excluded from the central government relief package. On the other hand, local structures may be more open to capture. For example, after a serious drought in 2002 in Ethiopia, community-based targeting of food transfers was targeted to households with less access to support from relatives or friends but was also twice as likely to be targeted to households with close associates in official positions (Caeyers and Dercon, 2012).

A range of non-state institutions are also particularly active in giving voice to specific groups or serving populations beyond the reach of the state. Depending on the context, these institutions may be in a unique position to gather information on the needs of specific groups, and/or be credible partners for delivering assistance in an emergency.

There are a broad range of examples of such institutions. Illegal urban settlements sometimes have recognized local leaders who facilitate access to state services and social benefits and are accountable to local populations (e.g. in urban India^[35]). Recognized local NGOs also often provide a range of services and sometimes coordinate their efforts within a geographic area under an umbrella organization (e.g. in urban Brazil^[36]); they may have years of experience being accountable to both their donors and their beneficiaries. International NGOs (e.g. BRAC, Oxfam) have a strong presence across a range of contexts. There are also private associations with specific purposes, which can, in some instances, have wide coverage. For example, 24% of Africans participated in community-organised savings groups (Findex, 2014). Membership may be even higher in rural areas: 53% of a rural Kenyan sample were members of a rotating savings group (ROSCA) (Orkin and Walker, 2020). In Ethiopia, over 90% of villagers in two separate samples are members of burial associations (Dercon et al., 2006; Bernard et al., 2014). Another type of private associations are professional organizations, which may be active in sectors that employ many  informal or poor workers. For example, India’s relief package encourages Building and Other Construction Worker Welfare Funds to provide emergency assistance.^[37]

These institutions could play a range of roles. Some will likely repurpose themselves to provide emergency assistance in the current crisis spontaneously, an effort that could be leveraged and complemented by governments. Governments could leverage their infrastructure to gather information on the needs of their many beneficiaries. Many have a network of workers in remote areas, who are already part of public health responses, e.g. an NGO trained community volunteers, religious leaders and traditional healers in Senegal to monitor for common diseases in their villages.^[38] They could be used to recruit people into government programmes in environments where communication about new programmes is difficult. For instance, Kenya used ROSCAs to enroll participants into its new health insurance scheme (Oraro and Wyss, 2018). India used National Rural Livelihood Missions and their network of Self-Help-Groups (SHG) to advertise and enrol people into many development programmes, such as rural sanitation (Swachh Bharat Mission).

It may be unusual to involve non-state actors directly in provision of state assistance, but unprecedented times may call for exploring new opportunities. Although there may be justifiable concerns about a lack of accountability, institutions with a long history and broad base of membership may be particularly resistant to the capture of transfers (Dercon et al., 2006). They already need to be locally legitimate to sustain their work, as they have no formal legal authority and are regulated largely by social sanction (Olken and Singhal, 2011). The most important concern is that community institutions remain inclusive in times of crisis and share broadly the emergency resources given to them (Gugerty and Kremer, 2008). For example, rural communities need to provide support to returning migrants rather than banning them from coming home for fear of the contagion. Another concern is that non-state institutions enrolled in social protection efforts need also be onboard with governments’ public health strategy (e.g. some religious organisations have been promoting alternative ways of dealing with the pandemic^[39]).

Conclusion

Our analysis highlights that governments in developing countries will have to find creative solutions to build a comprehensive social protection response to the economic impacts of the COVID-19 epidemic. Job retention programmes already existed in some countries (e.g. Brazil) and could be used more widely to protect employment in the formal sector.^[40] Some governments, as in Chile or India, have leveraged id-linked bank accounts opened for financial inclusion purposes to provide direct support to the poor. Even populations that live at the margins of social protection systems, like migrant workers in the informal sector who are not registered where they work, can be reached through associations that work with them (like the Aajeevika Bureau for internal migrants in India).

Yet, any government response will be imperfectly targeted, with important inclusion and exclusion errors. Government responses based on social insurance programmes may reach many formal employees and registered self-employed (although coarsely), but will miss the informal sector, which is an important part of developing countries’ workforce. Social assistance programmes allow governments to broaden the base of their response, but their targeting is always specific to a particular dimension of poverty, and their delivery is often plagued with “leakages”. Involving local governments or non-state actors to help provide assistance presents clear opportunities, but also runs the risk of resources being diverted by local elites or used for clientelism. Together, these policies may reach some households through several channels at once while leaving others with no direct support. However, in an emergency, the benefits from improving targeting and reducing leakages may not exceed the costs if an improved process leads to long delays in implementation.

Fortunately, even imperfectly targeted transfers will reach some “left-behind” households through family, informal, or formal sharing structures. Existing social protection transfers are often widely shared in families and extended networks even outside times of crisis. For instance, South African pensions received by grandparents benefit grandchildren (Duflo, 2003) and young adults in the household (Ardington et al., 2009). Households ineligible for Progresa cash transfers still get loans and gifts from eligible households in the same village and have higher food consumption (Angelucci and di Giorgi, 2009). Government could acknowledge explicitly that their emergency response will not reach all households and encourage beneficiaries to share their resources with others whom they identify as being in need, possibly subsidizing means of money transfers (e.g. reducing fees for bank or mobile money transfers^[41]). Charitable giving could be encouraged in response to the crisis and channelled to vulnerable populations (e.g. zakat funds in Muslim communities in Bangladesh before Ramadam^[42]). In fact, national funds run by governments and businesses have already raised record amounts in some countries.^[43]

The challenge of mitigating the economic effects of the pandemic is enormous. Any solution will be flawed in many ways because speed is of the essence. But governments, donors and civil societies have made major gains in the last 30 years in building infrastructure to reach the poorest. If internal and external financing can be found, developing countries can use this to create the economic space for an effective public health response.

Endnotes

[*] The authors work on social insurance, social assistance, and informal structures of risk-sharing in a range of developing countries, including Brazil, Ethiopia, India, Kenya, and South Africa. We thank Arun Advani, Sebastian Axbard, Anne Brockmeyer, Ranil Dissanayake, Simon Franklin, Lucie Gadenne, Rema Hanna, Lukas Hensel, Mahreen Khan, Julien Labonne, Lorenzo Lagos, Axel Eizmendi Larrinaga, Gianmarco Leon, Winnie Mughogho, Joana Naritomi, Paul Niehaus, Barbara Petrongolo, Simon Quinn, Moizza Sarwar, Alex Solis, and Michael Walker for their thoughtful feedback and explanations of some of the policies implemented in different countries. All remaining errors are our own.

^[1] Financial Times, 2020, “Coronavirus Tracked: The Latest Figures as the Pandemic Spreads.”

^[2] Oxford COVID-19 Government Response Tracker; Nature News, 2 April 2020, “How Poorer Countries are Scrambling to Prevent a Coronavirus Disaster.”

^[3] UNU-WIDER, 2020, “Estimates of the Impact Of Covid-19 on Global Poverty.”

^[4] See http://www.ugogentilini.net/ for the World Bank and ILO’s updated list of policies adopted worldwide.

^[5] See for instance: Time, 7 April 2020, “Fewer Doctors, Fewer Ventilators: African Countries Fear They Are Defenseless Against Inevitable Spread of Coronavirus;” Dahab et al. (2020); World Politics Review, 20 March 2020, “Refugees Are Being Ignored Amid the COVID-19 Crisis.”

^[6] Financial Times, 6 April 2020, “Iran Steps Up Support for Citizens as it Eases Coronavirus Controls.”

^[7] The Economist, 2 April 2020, “Emerging-market Lockdowns Match Rich-world Ones. The Handouts Do Not.”

^[8] IMF, 9 March 2020, “How the IMF Can Help Countries Address the Economic Impact of Coronavirus.” Hausman, R., 24 March 2020, “Flattening the COVID-19 Curve in Developing Countries.”

^[9] Le Monde, 9 April 2020, “L’Iran Met Fin Au Confinement Pour Éviter L’effondrement Économique.”

^[10] For further reading, see the articles listed at the end of the reference section.

^[11] Conflict states face additional specific challenges (e.g. Dahab et al. 2020). See also OCHA, 30 March 2020, “Pooled Funds Response To COVID-19” on co-ordinated international responses.

^[12] See G. Giupponi and C. Landais, 1 April 2020, “Building Effective Short-time Work Schemes for the Covid-19 Crisis” for a discussion of key implementation details that are likely relevant in all countries.

^[13] The Nation, 9 April 2020, “Cabinet Okays Compensation for Employees of Suspended Hotel, Lodging Businesses.”

^[14] MapNews, 26 March 2020, “Covid-19: Net Monthly Flat-rate Allowance of MAD 2,000 for Employees Declared to Social Security Fund in Temporary Work Stoppage.”

^[15] Secretaria Especial de Previdência e Trabalho, 1 April 2020, “Programa Emergencial de Manutenção do Emprego e da Renda.” Department of Labour, 26 March 2020, “Disaster Management Act: Directive: Coronavirus Covid19 Temporary Employee / Employer Relief Scheme.”

^[16] For example, Kenya has implemented several policies to relieve firms’ tax burden (see the statement by President Uhuru Kenyatta on 25 March 2020).

^[17] The Economic Times, 31 March 2020, “Finance Minister Nirmala Sitharaman Announces Rs 1.7 Lakh Crore Relief Package For Poor.”

^[18] Self-employed workers are often not required to declare their income level for tax purposes. They may have to declare their gross revenue, but this may be a poor measure of their income, e.g. if they have sizable input cost or under-reported their past revenue to minimize tax liabilities.

^[19] O Globo, 7 April, 2020, “Tire Suas Dúvidas Sobre o Auxílio Emergencial de R$ 600.”

^[20] The Guardian, 2 April 2020, “Millions in UK ‘could slip through virus wage safety net.”

^[21] South Africa, for instance, quickly made available R500 million to assist small and medium enterpises (see the statement by President Cyril Ramaphosa on 24 March 2020).

^[22]Bassier, M., J. Budlender, M. Leibbrandt, R. Zizzamia, V. Ranchhod. 31 March 2020. “South Africa Can – And Should – Top Up Child Support Grants To Avoid A Humanitarian Crisis.”

^[23] The Economic Times, 31 March 2020. “FM Nirmala Sitharaman Announces Rs 1.7 Lakh Crore Relief Package For Poor.”

^[24] Tempo.Co, 5 April 2020, “Dampak Covid-19, PKH Disalurkan Bulanan Mulai April.”

^[25] See the statement by President Uhuru Kenyatta on 25 March 2020.

^[26] The name of the programme is “Bonus I stay at home”. Labeling assistance programmes may be an effective way to induce compliance to public health policies (Benhassine et al. 2015 show that labeling a cash transfer to promote children’s education is as effective as making it conditional on enrolment).

^[27] The Conversation, 1 April 2020, “Coronavirus: How Pakistan Is Using Technology To Disperse Cash To People In Need.”

^[28] India Today, 26 March 2020, “Bihar Govt To Bear Expenses Of Migrant Workers Stranded In Other States: Nitish Kumar.”

^[29]El Comercio, 1 April 2020, “¿Cómo Saber Quiénes Más Recibirán El Bono de 380 Soles por Coronavirus en Perú?.”

^[30] The World Food Programme and United Nations Office for the Coordination of Humanitarian Affairs collaborate on early warning systems for severe food insecurity https://hungermap.wfp.org/.

^[31] See interviews with Hans Rosling: Science, 2 December 2014. “Star Statistician Hans Rosling Takes on Ebola” and https://www.youtube.com/watch?v=60H12HUAb6M.

^[32] KT Press, 29 March 2020, “Rwanda: How COVID-19 Relief Distribution Will Work.” The usual social protection also involves communities in targeting to verify that applicants for social assistance are needy (see Republic of Rwanda, 3 February 2015, “Community-led Ubudehe Categorisation Kicks Off”).

^[33] IGIHE, 6 April 2020, “Coping: Kigali City Opens 3260 Toll–free Line to Address Food Needs Inquiries.”

^[34] News18, 28 March 2020, “Govt Changes Rules to Help Migrant Workers Amid Covid-19 Lockdown, State Disaster Funds to be Used for Providing Food, Shelter.”

^[35] Ideas for India, 20 July 2017, “India’s Slum Leaders.”

^[36] E.g. https://redesdamare.org.br/br/quemsomos/coronavirus for the Mare favela in Rio de Janeiro.

^[37] Economic Times, 26 March 2020, “Realtors Say Govt’s Directive to Use Welfare Fund to Help Labourers’ to Mitigate Epidemic Loss.”

^[38] Reuters, 25 March 2020, “Using Lessons from Ebola, West Africa Prepares Remote Villages for Coronavirus.”

^[39] The Diplomat, 25 March 2020, “Sociocultural and Religious Factors Complicate India’s COVID-19 Response.” Oxfam Blogs, 27 March 2020, “Across Africa, Covid-19 Heightens Tension Between Faith and Science.”

^[40] As a response to the crisis, China has helped firms but does not seem to have protected employment (South China Morning Post, 25 March 2020, “China is Winning the Covid-19 Fight but Losing the Economic War”).

^[41] Transfer fees for Kenya’s popular mobile money system were recently waived, although for a public health reason (Finextra, 16 March 2020, “Covid-19: M-pesa Waives Fees to Discourage Cash Usage”).

^[42] Atlantic Council, 30 March 2020, “Defusing Bangladesh’s Covid-19 Time Bomb.”

^[43] South Africa’s Solidarity Fund, a partnership of government and business, has raised £85 million in two weeks, £25 million from donations from ordinary citizens (https://www.solidarityfund.co.za/; Cape Talk, 2 April 2020, “Thousands of Ordinary South Africans Have Contributed to the Solidarity Fund”). Nigeria’s similar version, run by the central bank, raised £33 million in a week. CNBC Africa, 2 April 2020, “Nigeria’s Private Sector Coalition Raises N15.3bn to Fight Covid-19.”

The post Social Protection Response to the COVID-19 Crisis: Options for Developing Countries appeared first on Economics for Inclusive Prosperity.

To avoid a social debacle and stabilize workers’ labor income during the lockdown, two broad policy tools have been tested, sometimes simultaneously: job protection through soft credits and direct subsidies to firms conditioned on avoiding layoffs and, if the crisis is such that not all jobs can be preserved, income protection through the broadening and strengthening of unemployment insurance to workers.

Is this the right policy choice? In the developed world, yes. As a recent theoretical paper analyzing the economic impact of COVIC-19 suggests, in the event of a lockdown of contact-intensive sectors, “full insurance payments to affected workers can achieve the first-best allocation”.[1] However, although job protection (as opposed to income protection) may generally hinder the efficient allocation of resources (for example, by inhibiting labor turnover to accommodate changes in technology), in times of exceptional crisis a policy based solely on income protection can lead to an excessive volume of layoffs, generating permanent collateral damages from a transitory shock. Hence, the benefits of combining both employment and unemployment subsidies in the emergency.

Is this the right policy choice in the developing world? Probably, but it is not nearly enough. There is a critical shortcoming to these income-protection policies: by definition, they only cover formal salaried workers. And, in the developing world, this accounts for half of the labor force, at best. There is an important distinction, however, within this group of exclude outsiders. Whereas informal salaried workers are an anomaly that can, in principle, be contained with better monitoring, and lower labor taxes and administrative costs, the so-called “self-employed” or independent workers, is excluded legally, by design. And there are a lot of them.

Let’s put things in perspective: whereas in OECD countries only 15% of the employed is self-employed, in Latin America this number more than doubles: independents amount to 25% of total employment in Argentina, 28% in Chile and Uruguay 28%, 30% in Brazil and Mexico, and more than 50% in Peru and Colombia.

Unlike formal salaried workers, the self-employed are fully exposed to drops in their monthly earnings –in tranquil times and, much more so, during dramatic crises.

For starters, in most countries, labor benefits are tied to jobs. This makes historical sense: those benefits are the product of decades-old struggles between activity-specific unions and business chambers and, as a result, were instrumented for union insiders and, by extension, non-unionized salaried workers in the same activity. These benefits include working hours, licenses, on-the-job training and severance payments –and social security, which still is fundamentally contributory in nature in most countries and thus restricted to formal salaried employees who contribute through payroll taxes, thus deepening the inequality in access to the pension system.[2][3]

Moreover, the income instability of the independent worker is highly procyclical: in a context of a drastic activity collapse, not only do they see their hours worked –and the associated labor income– reduced; as noted, none of the income-stabilizing measures listed above protects them, pushing the independent worker to the welfare line.

Protect people, Austrian style

In 2003, Austria implemented a reform that abolished severance payments by replacing them with occupational pension accounts to which the employer generates monthly contributions (equal to 1.53 percent of the worker’s salary) to a segregated pension account that accrues to the worker only after a layoff or a quit, thus providing some limited income protection.

More precisely, upon termination of an employment relationship, the worker owns the accumulated “portable” pension wealth, which is transferred to the new employer if the worker is re-employed. Otherwise, access to the funds is regulated to avoid depleting the pension account in good times: they are available only after three years of tenure, and could be drawn in case of a layoff, when firm and worker agree to terminate the relationship, or after the end of a temporary contract. By contrast, when the worker quits her firm (or is dismissed for misconduct), he keeps the claim but cannot withdraw the money, to avoid misuse or fraud.

This scheme can be easily extended to independent workers, in a way that allow them to save for the rainy days much in the same way as the Austrian worker does while on the job. Indeed, the Corporate Staff and Self-Employment Provision Act of January 2008 broaden the coverage of the Austrian scheme to include self-employed and freelancers. Since January 1, 2008, Austrian employers are required to pay 1.53% contributions to a self-employment provision fund for freelance employees.

More in general, one could imagine a new Regime for Independent Workers under which registered workers set a benefits account to which, for each payment that the worker receives, a proportional sum is transferred directly by the payer. How much will depend on the scope of the coverage. For example, it would be natural to allocate some money for sick and maternity leaves and holidays, in addition to unemployment insurance. It should not be difficult to establish categories by, say, a 12-month moving average of labor earnings, and to estimate declining contribution factors based for each of those brackets to account for the fact that the pension account is meant to secure an income floor. Similarly, while a time tenure may not apply in all cases, withdrawing rules can emulate the Austrian model: money from this account would be withdrawn only if the worker´s registered income in a predetermined period of time falls below a threshold level.

A “grey zone” regime: The case of faux independents

A frequent problem in countries with a high proportion of independent work is the “false” or “bogus” self-employment which refers to cases in which firms misclassify what should otherwise be an employment relationship as a relationship between a firm and an independent contractor to avoid taxes and regulations. Many workers lie in this “grey zone” between employment and self-employment: presumably, they choose when and where to work but, in reality, they are economically dependent from a unique “client” in a liaison virtually indistinguishable from formal salaried employment. These situations are often the result of deliberate illegal practices to avoid employment-related charges and hiring bans, both in the private and the public sectors –it is also close, albeit not identical, to the particular case of the drivers working for raid-hailing companies.

Addressing this loophole, many countries have extended social protection to individuals in this situation (OECD, 2019). In 2012, Portugal broaden unemployment protection to “dependent” self-employed workers. The criteria established to determine a “dependent self-employed person” was that at least 80% of the worker’s annual income has come from a single client (and in 2018, the criterion was reduced to 50%, further expanding coverage). On the other hand, Spain has a labor category called “economically dependent self-employed worker” (TRADE, for its acronym in Spanish) that allows access to social protection like health and accident insurance, pensions and unemployment benefits to workers whose income depends on a single client in more than 75%.

The strengthening of these intermediate figures is the natural way to extend benefits to faux independents and, coupled with the new regime proposed here, should fill in gaps of a labor benefits net for the whole span of independent workers.

A badly needed second best

Remedies to include no salaried workers are not without their disadvantages. For example, the Austrian model can generate financial inefficiencies: if a worker maintains a long-term relationship with an employer, funds accumulate in an occupational pension account that could otherwise be used for consumption or investment decisions. However, if the regime addresses this caveat by allowing employees to withdraw funds after a certain contribution period while still employed, excessive withdrawals may weaken the income coverage upon termination of employment –something not unusual in the Austrian experience (Hofer, Schuh & Walch, 2012). Withdrawal conditions should carefully balance these two risks.

Similarly, a “grey zone” regime can be used perversely by firms to mask salaried relationships. Eligibility criteria must be clearly defined and easily identifiable since vague definitions of “dependent self-employment” come at the risk of creating two rather than just one gray zone: one between “employees” and this “third category” of workers; and one between this “third category” and the self-employed (OECD, 2019).

That said, nothing can be more damaging to the independent worker´s wellbeing than inaction. Indeed, the COVID-19 pandemic only highlighted the huge inequalities in the safety nets between developed and developing countries, in particular, those arising from the prevalence of independent workers in the latter group. This crisis will surely widen the schism between countries and, within countries, between insiders and outsiders of the labor force. This duality should not addressed as part of the policy response to the crisis. If not, regardless of the size of the income-protection policies that developing countries can afford, disparities in labor markets will deepen the toll of the corona crisis on poverty and inequality.

Endnotes

[1] Guerrieri et al. (2020), “Macroeconomic Implications of COVID-19: Can Negative Supply Shocks Cause Demand Shortages?”, NBER Working Paper No. 26918.

[2] In those cases, the employee can choose between receiving the severance payment all at once or applying it toward a future pension. See Kettemann, Kramarz & Zweimüller (2017).

[3] More recently, as countries try to mitigate this inequality by introducing a pillar of universal benefits, the divide between contributing salaried workers and non-contributing independent ones deepens the structural imbalances between contributions and benefits within the system, increasing the contingent social security debt.

The post Work after COVID: A New Regime for Independent Workers appeared first on Economics for Inclusive Prosperity.

In the absence of mass testing for the covid-19, the lockdown is an efficient strategy because its expected economic cost is smaller than the expected value of the lives lost in the alternative laissez-faire policy (Thunstrom et al., 2020). Exiting from this stalemate is a complex matter because freeing people from confinement could ignite a second wave of contagion and deaths. Some estimates using Markov pandemic dynamics suggests that in the absence of testing and vaccine solutions, strong social distancing measures could last for more than a year (Atkeson (2020), Alvarez et al. (2020)), yielding severe economic and social consequences.

A key element to reduce the economic consequences of covid-19 is the ability to test individuals, given the large prevalence of asymptomatic but highly contagious infected people in the population. Mass reliable testing would allow to free people tested negative to bring them back to work in strategic sectors of the economy, without risking a second wave of contagion. As shown by the experience of South Korea, mass testing is crucial to control the pandemia (Cheong, 2020). As stated by Dewatripont et al. (2020), “restarting production in the economy requires the reliable identification of individuals who will not contract the virus or transmit it to others, whether they have previously displayed the associated symptoms or not”. The extremely limited testing capacity in many countries reduces our expectation of a rapid exit from the current lockdown strategy.

There is thus an obvious argument for a war-like investment plan in the covid-19 testing capacity. This will take some time. In this paper, I propose to complement this medium-term plan with an immediate expansion of the testing capacity by using group testing. It consists in pooling the individual samples that would be tested for the presence of the virus. By nature, the group test is negative if none of the individual samples in the group is infected, and it will positive otherwise. Obviously, this strategy would be particularly useful when the prevalence rate is small. This strategy has been used already in the case of the HIV epidemy (May et al. , 2010). Dorfman (1943) showed that it is a cost-minimizing strategy to detect defects in large populations in various contexts (defects in production, syphilis among army men,…).[1] Contrary to Dorfman, I don’t attempt to identify infected individuals. I rather determine the size of group testing that maximizes the number of individuals whose testing demonstrates they are not infected. This is because the value of information from the test does not come from the treatment of infected people in the absence of an efficient drug to do that. In the context of covid-19, the value of the test rather comes from sending healthy people back to work as soon as possible, without risking infection.

The model and its solution

Suppose that the prevalence rate of the virus in the target population is p. There exists a perfectly reliable test to determine whether the virus is present in a sample, i.e., in a respiratory swab or in a group of such swabs.  In the case of group testing, a negative result implies that none of the swabs in the sample contains the virus. A positive result means that at least one swab in the sample contains the virus, but the specific swabs that are infected cannot be identified. The testing capacity is assumed to be extremely limited in the sense that even group testing will not allow for testing the entire population.

I assume that there exists no treatment for the covid. The only benefit of the test is thus to allow people with a negative test to get back to work. I also assume that when a group is detected with the virus, their members remain confined. The scarcity of tests obviously implies that it is better to use a test to detect the virus in another untested group than to try to discover who is infected in a positive group.

In the spirit of Dorfman (1943), I hereafter characterize the size of the group testing that maximizes the expected number of people that can be freed from confinement. Let n denote the size of the groups to be tested. If n is too large, too many groups will be detected with the virus, and that will reduce the expected number of people who will be allowed to get back to work. Technically, the frequency of groups tested negative is equal to (1 – p)ⁿ, so that the expected number of people freed from confinement with a single test is equal to N = n(1 – p)ⁿ.[2] The optimal size of group testing thus satisfies the following first-order condition: The optimal size of the group is decreasing with the prevalence ratio. It is optimal that the group size be approximately equal to the inverse of the prevalence ratio. The above equation gives us the following expected number N of people back to work with a single test:The expected number of people freed from confinement with a single test is decreasing in the prevalence ratio.

I can also value the benefit of increasing the testing capacity. To do this, I need to measure the social cost q of individual confinement. Suppose that the optimal confinement strategy in the absence of testing is to remain idle for two months.[3] Therefore, I assume that this social cost equals two months of GDP per capita.[4]  For the EU whose GDP/cap is approximately 31.000 EUR per annum, this corresponds to q=5167 EUR. The social value of an individual test is thus equal qN. This should be compared to the cost of producing this test. Table 1 characterizes the optimal strategy for different prevalence ratios.

Table 1: Optimal group testing strategy as a function of the prevalence rate in the target population. I assume that q=5167 EUR.

For example, if 5% of the target population is infected, it is optimal to test people in groups of 19. Almost 38% of these groups will be tested negative. In expectation, this will release 7.17 individuals from confinement, thereby generating a social benefit of 37.046 EUR per test. Because the cost of a test is around 40 EUR, expanding the capacity of covid-19 testing is a no-brainer. It is interesting to compare this group testing strategy with the standard individual testing strategy with p=5%. One individual test has 95% chance to be negative. One test can thus free 0.95 individual in expectation. It is thus 87% less efficient than the optimal pooling strategy.

Concluding remarks

Given the extreme economic and social costs of the lockdown, it is crucial to think ahead about an exit strategy. To escape a rebound in the contagion, the only feasible exit scenario is to test people on a massive scale to get people tested negative back to work. Expanding testing capacity by the millions will not be technically possible in the short run. The only alternative is group testing. I therefore propose the following strategy. First, we must solve the problem that nobody really knows the prevalence rate of covid-19 in the population, because tests have most often been targeted to individuals exhibiting symptoms of the coronavirus.[5] So, I propose to test a large representative sample of the population, independently of symptoms.[6] This would allow us to calibrate the prevalence ratio p which is necessary to determine the optimal pooled testing strategy. This will allow us to implement the optimal group testing in a second stage, up to the full testing capacity.

In this paper, I focused on releasing people from confinement, which require testing for the virus. I could have alternatively examined the problem of releasing people who have developed the antibodies, so that they could be used to services to the infected patients without taking the contagion risk. The same logic of group testing could be used for this alternative objective by using serologic group testing to maximize the identification of this group of individuals.

Endnotes

[1] My model differs from Dorfman (1943) by its objective function. Dorfman characterizes a two-stage strategy to identify the infected individuals. It first tests the groups, and then tests all individuals in groups which test positive.

[2] For simplicity, I assume independence of the health status within the group members conditional to belonging to the group.

[3] This is subject to controversy. I rely here on the work by Alvarez et al. (2020) who show using a SIR model (Atkeson (2020)) that a strong confinement rule is optimal for at least two months.

[4] This approach obviously provides a lower bound of the social benefit of exiting from confinement, at least in the early stage of the exit. This is because it will be optimal to target the group testing to people with the most crucial competences for the restart of the economy.

[5] The recent German initiative to randomly test 100.000 people is welcomed.

[6] I am not the only one to recommand this key policy. See for example Dewatripont et al. (2020) and Galeotti and Surico (2020).

The post Optimal Group Testing to Exit the Covid Confinement appeared first on Economics for Inclusive Prosperity.

-Theodore Roosevelt [1]

We are at a moment when governments must make choices with life-and-death consequences.  State and national governments have imposed quarantines.  The US Congress passed legislation approving cash payments to individuals and loans and bailouts to businesses and industry.  Government takeover of some functions that had been private appears imminent.  These choices have unprecedented scale and scope.  Decisions and allocations that had been made democratically, or in markets, or by communities, now reside in the portfolio of bureaucrats.

These shifts from one class of institution to another – from markets to hierarchy, or from community to hierarchy – have downstream implications on our society that merit consideration.  While we reorganize our decision architecture to meet the pandemic’s challenges, we may inadvertently damage our civic capacity, the social fabric that sustains democracy and community organization.  To borrow the phrasing of Acemoglu and Robinson, these actions may push us out of the narrow corridor by reducing our civic capacity.

The Choice: Diverse Institutional Forms to Make Social Decisions

A flourishing society and a moral political economy require a diversity of institutional types, including community-based organizations and democratic institutions to push back against markets and hierarchies.  Each institution should be suited to its task and complement the weaknesses of others.

Achieving a robust portfolio of institutions requires engagement with multiple disciplines, not only economics. To that end, in each of the past two years an interdisciplinary group of scholars has convened at the University of Michigan to contemplate what we call The Choice.  The Choice refers to society’s choice of what institutional form to use as it allocates resources and takes actions. Owing to technology, we have more flexibility in the institutions we choose.   In addition to markets and hierarchies, we can create democratic bodies, empower communities  to collectively create and enforce rules and norms (also called self-organization), or we can hire a team to write an algorithm.

The best short- and long-term answers to The Choice are often counterintuitive.  Ironically, the logic of market efficiency applies quite well to donated goods. Candice Pendergast showed that food banks perform much better if they use markets to allocate their donations.  Similarly, Richard Titmuss found markets to procure blood to be far less effective than relying on volunteer organizations. That’s not the end of the story. The blood distribution problem is solved via markets: donated blood is sold to hospitals, with market-incentivized innovations to improve the supply chain.  And then how do hospitals make purchasing decisions?  Hierarchically.

As should be clear, The Choice offers up any number of perplexing questions.  To be honest, we saw our events – The Choice conferences – as a way to engage academics in some big think fun.  We framed the conferences in part as an enlargement of a century-old debate about how to allocate goods: use markets or central planning?   We merely expanded the question of Smith vs Weber to include Mansbridge, Ostrom, and Bezos.

And now, suddenly, The Choice is all too real. The current pandemic offers up multiple instances in which society makes a choice among types of institutions.  Consider the task of allocating limited ICU beds or COVID tests.  We could use a market model.  Prices would equilibrate to where supply equals demand – an efficient outcome, but only in the economic sense.  Rich people would be tested and get beds.  Poor people would not.

We could instead create a hierarchy that processes applications.   People could no longer buy beds or tests, but this new process would create other challenges, notably guarding against corruption.

But why not other institutions? We could elect local boards that vote on who receives beds, or at least decide on the criteria.  The democratic solution might not be as efficient as a market or a hierarchy, but it could be fairer.  We might empower each community to self-enforce the criteria. Finally, we could leverage big data and have people type information into a website and allow algorithms select who gets a bed or a test, applying deep learning tools.

We also confront The Choice as we decide how to produce more masks and respirators and emergency responders.  Do we offer a prize (a market solution)?  Do we rally the nation’s craftiest via social media to stitch their stacks of quilting fabric into masks (a community solution)?  Does the government impose the emergency powers ordinarily reserved for wartime and demand that Ford Motor Company re-engineer fan parts into ventilators?  Do we empower the military to expand health care services?

More broadly, how do we prevent economic collapse?  Should the government protect returns on investments and business expenses?   Should they helicopter money and let the market work?  Or should we leave the rescue to self-organization, like the Stanford students’ GoFundMe to support the university’s furloughed staff? Similar questions play out at every level of government. Should Philadelphia, which is short of ICU beds, invoke powers of eminent domain to take a vacant hospital at what would have been a fair price last week?  Or should they continue to try to negotiate a market transaction knowing they are on the losing end of a holdup problem?

Ironically, even though over the past quarter century markets have been supplanting hierarchies worldwide, and we apply algorithms to choose driving routes, guide purchases, split checks and even find life partners, the great majority of pandemic policy proposals involve central planning.  We see a few market proposals and some algorithms, but far fewer democratic or community-based solutions.  A notable example of the latter is a proposal to call for volunteers who would be injected with the virus in order to test vaccines.

Long Term Implications: Spillovers and a Healthy Civic Capacity

We should be concerned about the lack of diversity in institutional types. As we rush to formulate a collective response, we should keep three lessons in mind.

First, we need to protect—and even transform—our civic capacity.  Institutions do more than allocate resources; they determine who gets what information, influence our belief systems, encourage certain behaviors and norms over others, and they can enhance or destroy networks of trust. These attributes – knowledge, beliefs, behaviors and norms, and trust relations – make up a society’s civic capacity.  And we need civic capacity for society to flourish.

When the government takes control and imposes restrictions on what businesses and organizations stay open and whether we can leave our homes, they remove individual agency and mutual reliance.  It literally wears away at our social fabric.  To counter that decay as our quarantines reduce connectedness, it becomes even more important to involve institutions that encourage interaction.  (Hint: we probably want more democratic deliberation at the level of neighborhood and town.)

The types of spillovers produced are relatively straightforward. Hierarchy promotes specialized knowledge, rule following, and networks organized by authority.   Hierarchies are not good at adapting on the fly.  Markets may be better at that, but at a cost.  Markets promote specialized knowledge acquisition, strategic, often self-interested behavior, a belief in the rationality and self-interest of others, and network connections formed for material advantage.

Democratic institutions can produce favorable spillovers.  Deliberative democratic institutions promote general knowledge, norms of reciprocity, beliefs in collective interest, and dense social networks.   Allowing communities to organize their own solutions has even more beneficial spillovers to civic capacity.  Community interactions promote common knowledge of processes, high degrees of trust, mutual understanding, beliefs in equality, and rich social networks.  Because algorithms ask the user to input her preferences, it can encourage self-reflection and self-interest, but may reduce reliance between people.

Second, evidence of how the virus has spread across the globe shows that cultural differences matter as much or more than institutional choices.  Thus, policy should focus as much on culture as outcomes.  Countries that have done best at containing the virus either score low on individualism (China, Korea) or high on rule-following (Germany) or both (Singapore). The United States scores almost pathologically high on individualism and low on long-term orientation.  We’re middling on rule-following.

Those features of our civic capacity bode ill for our long run capacity to handle a pandemic, leading to our third point.  This is not the first pandemic, and will not be the last, so building civic capacity may be as important as producing the most efficient immediate outcomes.

Consider two approaches to promote social distancing.  One is a purely hierarchical solution: a quarantine enforced by the police.  A second is a community-based solution: allowing communities to develop rules, norms and other enforcement mechanisms.  The best institutional solutions may well by hybrids.  A community may create democratic bodies to generate and deliberate ideas.  It might construct a market in which people are paid to enforce norms, or develop a mobile app (an algorithm) to coordinate activities to reduce crowds.  It may ask the police to be available as back-ups should self-organization fail; that complementarity will boost the effectiveness of community solutions.  Hierarchy is needed to break the collective action problems and coordination problems inherent to federal government.

The community-based approach may be less efficient initially, but it could build civic capacity in the form of stronger trust relations and other-focused behaviors that yield benefits two weeks, two months, or even two years from now.  At this moment, the economy needs an infusion of money badly.  It does so in part because Americans (both individuals and corporations) save so little.  A more equal wealth distribution and better saving habits would have us in a much better place.

In sum, in this time of crisis we must make decisions with care.  We need long-term thinking when answering The Choice. Having the military take over health care and allowing the government to impose quarantines and closures of business may flatten that curve now.  But what effects do they have on our civic capacity to meet future challenges?  As we take today’s most prudent measures to protect our physical health, we should also be mindful of our long-term social health.  As the turn toward hierarchies damages our capacity to support a thriving democracy, we might act now to introduce institutions in parallel to the hierarchical ones that will support our civic capacity.  If we do so, we may not only salvage our current social fabric, but weave one that is much better equipped to flatten future curves.

Endnotes

[1] “Theodore Roosevelt on Bravery: Lessons from the Most Courageous Leader of the Twentieth Century”, p.4, Skyhorse Publishing, Inc.

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The coronavirus claims will create a backlog that could take weeks or even months to work through, at a time when we desperately need the benefits to go out quickly to sustain families. Moreover, the relief bills currently under consideration in the House of Representatives and the Senate will deliver a large part of the aid through expansions of unemployment benefits, making it all the more important that the system handle claims quickly.

The unemployment insurance processing system is not prepared for this hundred-year flood. It has been starved of investment for decades: Federal funds to states for administering UI fell by 30 percent between 1999 and 2019.[2] As a result, the system is held together with duct tape and struggles even with normal recession-time claims levels; it is wholly unprepared to accommodate the current surge. Processing claims requires assessing them for eligibility and this is time consuming, usually requiring human involvement.

Desperate times call for desperate measures. There is a way to handle the spike in claims, get benefits out quickly, and ensure that public dollars are not wasted on invalid and inappropriate claims. Unemployment offices should presume that all applicants are eligible and prioritize paying claims without careful review. Then, when the initial wave is past and there is more breathing room, they should go back and review the claims, and, if necessary, collect overpayments.

Here’s how it would work: the first step the UI offices should take when confronted with a new, seemingly valid claim is to pay it, using a rule-of-thumb estimate of the benefit amount if this can be done faster than a more careful calculation. When they are able, they will go back and review eligibility more carefully. Paid claims that are found to have been eligible are fine – there is nothing more to do. When a claim is found that should not have been paid, the recipient should be notified and the UI office should calculate the amount of excess payment. When it issues tax forms next winter – anyone who receives unemployment benefits gets a 1099-G that is used for reporting UI benefits on the tax returns – these forms should note the overpayment. The recipient would then be liable for repaying the excess, when the crisis has hopefully receded. The federal government should provide additional processing resources to states that adopt the streamlined process.

This is not a perfect system. Many people will wind up owing money through honest mistakes or simply because they did not understand the extremely complex unemployment insurance rules, and paying a large tax bill, months after the money was spent, can be a big burden. People whose claims were denied would, as always, have an option to appeal. Beyond this, the tax bill shock could be mitigated by allowing individuals to repay over the course of several years, with repayment relief for lower income families. It may not be possible to collect every penny that is owed. This is a small price to pay to ensure that unemployment benefits go out quickly in this crisis. The damage to family pocketbooks and to overall demand in the economy from a bottleneck in the UI payments system will magnify the already catastrophic unemployment crisis, and the value of limiting them dwarfs the costs of overpayment during this crisis.

Last, it is important to note that this is not a substitute for investing substantial additional dollars in unemployment insurance program capacity, as is included in the bills currently under consideration. The offices will need this funding to process the wave of claims, even under our proposal. We also need to modernize the systems to handle later phases of this wave, and to prepare for the next one. In the meantime, our proposal is an expedient response to the current emergency and will help to limit the damage that the current unemployment crisis will cause.

Endnotes

[1] https://www.epi.org/blog/coronavirus-record-breaking-spike-in-ui-claims/

[2] https://www.nelp.org/publication/understanding-the-unemployment-provisions-of-the-families-first-coronavirus-response-act/

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The Covid-19 outbreak is a health shock rather than a standard slowdown in economic activity. It is materializing as an unavoidable temporary economic paralysis, and its consequences will likely amount to a severe contraction of the global economy and a global financial crisis. The collective attempts to avoid the spread of the virus are needed desperately, but such containment action will also likely lead to an almost full suspension of economic activity in many parts of the economy.

The recourse to standard expansionary fiscal and monetary policies may not be effective right now. Textbook expansionary policies try to stimulate demand, but people who simply stay at home are not currently responsive to such stimulus, which may in fact reduce these policies’ fire-power when it is needed later on. A “war time” economic thinking should dictate that the virus is the external enemy and needs to be defeated at all costs to recover an economy that functions in a regular way. It calls for a host of targeted policies, as suggested by the IMF Chief Economist Gita Gopinath early on.[1]

Part of this thinking is about figuring out the essence of the shock and its economic transmission in the short run. For macroeconomists, the crisis appears to currently materialize both as a demand shock and a supply disruption. It is also important to pin down whether the shock will lead to a liquidity or a solvency problem for the real sector.

A pure liquidity problem arises when one learns that the return coming today will instead come tomorrow; all that is needed is to manage liquidity accordingly, for example through a loan. A pure solvency problem is associated with a lack of long-term viability. Solvency issues do likely not apply to the majority of the businesses affected by the current paralysis. Once the epidemic is over and the economy recovers, most businesses should be as profitable as before. SMEs, however, may now go bankrupt. The effects from such default are well known: lay-offs, NPLs, weaker banks, weaker demand, sluggish investment, and a sluggish recovery.

Thus, the losses of the economic paralysis should be shared. Preserving the medium and long term continuity of businesses is important for the society.

How to address the liquidity squeeze faced by small businesses?

Several governments have already taken decisive action to address companies’ looming liquidity shortfalls. As a notable example, the German government was quick to legislate a package of economic measures, which includes tax deferrals, as well as unlimited access to loans via Germany’s state owned development bank KfW.[2]

While these policies are extremely welcome and legislation was rapid, there might still be an issue on the magnitude and timely implementation. First, tax deferrals will allow business to delay payment of outstanding tax liabilities. There is large variation across firms in how the magnitude of these liabilities compares to the dramatic reduction in revenues from the contraction in economic activity.

Second, it is unclear whether the administrative process involved in asking for emergency loans can be executed timely enough. For example, will the owner of a small café or a laundry store be able get access to such an emergency loan to service outstanding payments while demand has already virtually collapsed to zero?

Alternative: An immediate negative lump sum tax for SMEs

Many firms need liquidity urgently, it is a matter of weeks or even days. What if the government provides small businesses with an immediate negative lump sum tax?

The magnitude of this government transfer could be determined as a share of the firms’ revenues in 2019 (or a share of an average over past years). How high the share should be (it could in principle be 100% or even above) would depend on how much the government is willing to spend on the program.

The negative tax could come with some conditionality, for example could require firms to hold on to their employees. Thus an alternative way of implementing it, instead of transferring the revenue, can be to transfer the entire payroll wages based on the 2019 tax filings of the firms. For the next year if the company shows lower employment, then the difference can be returned to government. It could be targeted to a subset of firms or industries, ideally to firms below a certain employment threshold such as 500 who constitute small businesses, as for these firms the implementability constraint of the existing measures, pointed out above, likely binds. As argued, it could either come as full-on transfer (pretty much making it “helicopter money”) or it could be partly reversed in later tax years, when the economy has recovered.

A negative lump sum tax can be implemented fast and translates into cash flow for businesses

A negative lump sum tax would allow a cash transfer of a magnitude that could exceed that of a deferral of existing tax liabilities. Importantly, immediate means that the government literally directly wires the money to the business’ bank account via the existing tax system infrastructure, right now! It could be done without requiring firms to do any paper work whatsoever.

In the case of the US, this may be implemented directly via the Internal Revue Service (IRS). Upon successful legislation, the IRS, which should have the required information and infrastructure, could transfer money within days, the way it would do with a standard tax refund.

The government as “buyer of last resort”

The proposal closest to ours has been advocated by Emmanuel Saez and Gabriel Zucman.[3] We very much share their reasoning that an aggressive intervention is needed to prevent mass liquidation of businesses and mass layoffs of workers. Saez and Zucman also acknowledge that access to loans is not sufficient to provide a direct compensation of losses.

Our proposal of a negative tax has the benefit that practical implementation may be swift. For small businesses the problem is a lack of cash and time is already running out. Even if there is the political will to help these businesses, it is logistically tricky to actually send money to firms. Among the different institutions, it should be tax authority has the information and infrastructure needed for this. When the threat of bankruptcy is so immediate, it comes down to practical details such as having a database with the firms’ identities and bank account numbers which can be further linked to the U.S. Census database of the universe of firms.

We are aware that this is a rather blunt proposal, however we believe that out-of-the box thinking is urgently needed now. We also acknowledge that there are some parameters to be figured out, such as the type, magnitude and the universe of firms to be targeted. But the basic idea has the crucial benefit that it would directly and immediately address the disruptive liquidity needs of small businesses, where most employment occurs, and where we therefore think policy intervention currently has the most kick.

Policy is hopefully moving in the right direction

At today’s press conference, Treasury secretary Mnuchin mentioned that in addition to delaying payroll taxes, the US government now aims to provide cash to businesses and individuals, without getting into details. Our proposed policy of a negative lump sum tax, implemented through the IRS, can achieve exactly this in a quick manner. As we write, additional advice by macroeconomists, given with impressive dedication and at an unprecedented speed through social media, points in a similar direction, for instance by calling for a direct “liquidity life line” to European firms via loans from the EIB.[4] It is clear that economists hope to see an aggressive response by policy makers, which takes their advice seriously.

Endnotes

[1] https://voxeu.org/content/limiting-economic-fallout-coronavirus-large-targeted-policies

[2] See details here: https://www.bundesfinanzministerium.de/Content/DE/Pressemitteilungen/Finanzpolitik/2020/03/2020-03-13-download-en.pdf?__blob=publicationFile&v=2

[3] See details here: http://gabriel-zucman.eu/files/coronavirus.pdf

[4] See this very recent piece circulated by Markus Brunnermeier, Jean-Pierre Landau, Marco Pagano and Ricardo Reis: https://scholar.princeton.edu/sites/default/files/markus/files/covid_liquiditylifeline.pdf

Addendum

Supporting US SMEs during the pandemic: how much money gets us how far?

Both policy makers and the public are only beginning to grasp the full scope of the Covid-19 outbreak. While the economic activity needs to be reduced to avoid the spread of the virus, policy makers are intervening through various channels to give support to the economy. Strong interventions are justified based on the idea that the pandemic is temporary and liquidity rather than long-term viability issues are threatening households and firms.

Several economists have called into question textbook Keynesian stimulus measures as providing sufficient support to the economy during this unprecedented disruption.[1] Standard expansionary fiscal and monetary measures, so the reasoning goes, are not enough when people simply stay at home and economic activity is completely suspended. Those measures could be more effective later on, as the economy recovers from the pandemic as standard macroeconomic policy instruments may be conducive to a less sluggish recovery.

In a recent policy brief, Drechsel and Kalemli-Ozcan (March 17, 2020), we suggest a specific measure to support small and medium enterprises (SMEs).[2] We call for decisive action to fight firms’ looming liquidity shortfalls and go as far as proposing a negative lump sum tax. We floated this idea because we worry that some existing policies targeted towards SMEs — tax deferrals and emergency loans — may fall short in terms of size and rapid availability. A negative lump sum tax would allow an actual cash transfer, and immediate means that the government literally directly wires the money to the business’ bank account. This can be done, we argue, via the existing tax system infrastructure, the IRS in the case of the US.

How much money is needed?

In the following analysis, we want to substantiate our proposal by providing some quantitative analysis for the United States. The idea is to answer the question of how much money would get us how far in supporting US SMEs? To investigate this question, we resort to publicly available data from the US Census Bureau.

We previously suggested that the negative tax could be calculated either based firms’ revenues or based on their payroll. Since payroll is typically the largest cost item for businesses, and job losses started piling up, we now focus on the payroll. Note that the UK, for example, has now decided to cover 80% of wages for employees that cannot work because of the outbreak of the virus.[3]

We think that the numbers we provide below are useful even beyond our specific proposal. They could be helpful in putting other policies targeted at US businesses into a quantitative context. Table 1 presents statistics on employment and the size of the payroll across the US firm size distribution for the year 2017.

It is visible in Table 1 that a large bulk of US employment is accounted for by relatively small firms. Based on the information in Table 1, we provide calculations for different “policy scenarios”. In each scenario, we postulate that a certain group of firms (as defined by their size in terms of number of employees) receives direct cash payments to cover their payroll for a specific time period: one quarter, two quarters or a year. How costly would these policies be? Table 2 gives the answer by providing the corresponding calculations. To put dollar values into context, we show the cost of potential support policies as a share of US GDP and also include the employment numbers that would fall under a given policy as a share of total US employment.

Can the United States afford an intervention?

We believe that Table 2 provides a useful guideline to contextualize the magnitude of potential support payments to US SMEs. Suppose congress is willing to cover the entire payroll of all firms with more than less than 500 employees for 3 months. This policy would cover the wage bill of 61 Million US workers! This would cost around 3% of US annual GDP. Relative to the losses that are looming from businesses shutting down and workers loosing their job, we do not think the numbers in Table 2 are large enough for policy makers to shy away from aggressive policy. The policy can be made conditional on firms keeping the workers on their payroll and if not then the difference can be returned to the government during next year’s filing.

We also want to stress in that the calculations above, we abstract from general equilibrium effects. In particular, any intervention of the sort we suggest will likely have some multiplier effect. A given firm’s costs are in principle likely to include another firm’s revenue. If a given firm can cover their cost instead of delaying payment or defaulting, this will likely help other firms. Furthermore, making sure that firms will be able to cover their wage bill will put money in households’ pockets and alleviate additional negative effects of the contraction through the labor market.

Endnotes

[1] Some of the proposals made by academic economists are listed here: https://econfip.org/#

[2] The proposal is available at: https://econfip.org/policy-brief/are-standard-macro-policies-enough-to-deal-with-the-economic-fallout-from-a-global-pandemic/

[3] See details here: https://www.theguardian.com/uk-news/2020/mar/20/government-pay-wages-jobs-coronavirus-rishi-sunak?CMP=share_btn_tw

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If you have some savings and only a little debt, the situation is tricky enough. But since the debt-fuelled financial crisis in 2008, household debt has grown. In the UK, total household debt stood at £1.28 trillion for the period from April 2016 to March 2018 according to the Office of National Statistics (ONS).

Read more

The post Why Debt Relief Should Be the Answer to This Coronavirus Crash appeared first on Economics for Inclusive Prosperity.

The good news is that there are policy levers at our disposal to help with this. Already, we have seen governments of Denmark, Belgium, France, Germany, New Zealand and United Kingdom and others announce variants of plans to do this. Our ability to implement successful policies depend on the institutional features and existing programs that are in place. In this policy brief, I propose using the existing Unemployment Insurance (UI) system in the United States to provide relief to families and businesses. Here is the short of it—we need to (temporarily) convert the UI from a system that provides partial assistance to some jobseekers while they look for a job to a funding system that helps (1) preserve jobs through job sharing, (2) provide nearly full compensation for lost hours for those who see reduction in hours, and (3) provide nearly full compensation for lost earnings for those on layoffs, with the goal of making most of these layoffs temporary (“furloughs”) which allows workers to stay formally employed. And all of this needs to be paid for by the federal government. To put it simply, instead of UI being a payroll tax financed vehicle to help workers modestly while encouraging them to look for work, we want it to (temporarily) become a fully federally financed vehicle allowing workers to stay at home and companies to not go bankrupt.

UI is not the only vehicle to do something along these lines. A recent proposal by Saez and Zucman would create a different mechanism to compensate businesses for demand loss.[i] This is a smart proposal we should seriously look at. Similarly, Hubbard and Strain propose a loan to small and medium size businesses that would convert to a grant if employers do not lay off workers.[ii] At the same time, in my assessment, the UI system is up-and-running already here in the US, and we have all of the ingredients (including work sharing) in place for use. What we need to do is to change the parameters substantially, and (like we did during the Great Recession) fund it using federal dollars.

Here I lay out the key changes we need to put in place to obtain this temporary transformation, beginning with making UI generous enough to actually support workers to weather this storm at a time they cannot be expected to find a job. Next, I talk about expanding on the work-sharing component to keep workers on the payroll.

This is not meant to be a comprehensive economic plan to deal with the pandemic. There are many other steps. This includes shoring up paid sick and family leave, strengthening safety net programs like SNAP (“food stamps”), transfer funds state and local governments, and also additional stimulus measure to boost aggregate demand when the social-distancing period ends. However, helping workers and businesses directly harmed by the pandemic and the necessary public health response is the most important place to start.

Making UI cover full (or nearly full) paychecks

First, we need to substantially reduce eligibility requirements to help people access UI. Most importantly, we need to drop the requirements of a one week waiting period, and the requirement to be actively searching for a job. In addition, we need to reduce the past earnings requirement that keeps many workers with lower hours or tenure from qualifying for UI benefits. Many low-wage workers with limited hours just do not have sufficient past hours in the “base period” to qualify for UI. Allowing all workers who lost their jobs (not just those who are technically “laid off” as opposed to fired) can also help. And unlike the current system, the crisis response should also allow self-employed workers, including those in the gig economy, to apply. These changes can go a long way in making sure people affected by this downturn can actually access the UI system. While typically only around a quarter of unemployed workers in the US actually receive UI, the goal should be to move this much closer to one hundred percent.

Second, need to make UI much more generous to fill paychecks of people who are temporarily out of a job or face cuts in hours and earnings. We can do that via increasing the replacement rates for those who are laid off (temporarily or permanently). Replacement rates refer to the share of your normal income that you receive as UI benefits. These typically range between 33 and 55 percent across states. But there are also maximum benefit caps that vary considerably across states. So, if the replacement rate is 50% and the maximum weekly benefit is $500, and your usual earnings is 1500, you will actually receive $500/$1500 = 1/3 of your usual earnings replaced. My proposal would start with moving to a replacement rate of at least 75% and raising the cap on weekly benefits to $1,500. The goal is to cover much of the paychecks of most workers who are laid off.

In normal times, the concern with having a very high replacement rate is that it discourages job search as people take advantage of the generous benefits instead of looking harder. This is a reasonable concern in normal times. But this is not the concern now – we don’t really expect many of those laid off to be able to find jobs in this environment. Indeed, ideally most of those laid off will be so only temporarily, and will be called back once the pandemic subsides and the recovery begins. Therefore, in this case, providing a generous replacement rate of at least 75 percent (better perhaps at 80 or 85 percent) is a reasonable strategy that will get money in the hands of the people who are most strongly hurt by the crisis. This recognizes that the problem is not to help the unemployed along while they look for a job (which they cannot do very effectively right now) but rather to fill the holes in their budgets during this temporary pandemic.

Third, we need to help the currently unemployed who will have a hard time finding jobs by extending the maximum benefit duration. In normal times, workers are typically eligible for 26 weeks of UI. At the peak of the Great Recession, this was extended to as much as 99 weeks.  We don’t expect the pandemic related downturn to last anywhere near as long as the Great Recession. However, those who were unemployed even prior to the shock cannot be expected to find a job very easily. If someone has been unemployed for 25 weeks, we don’t want their benefits to run out next week because it’s going to be very hard to find a job right now. For this reason, I suggest that we expand the maximum benefit duration to 52 weeks immediately to avoid loss in benefits.

Helping keep workers on payroll

When it comes to layoffs, the goal should be to incentivize temporary layoffs (or “furloughs”) which keeps workers on payroll and allows workers to return easily. This also allows employees to potentially access some of their benefits. What this means is that the employer retains the worker while the federal government is replacing (much of) their earnings during a time where the government has essentially forced many workers to not be at work in order to fight a pandemic. Not all employers may use furlough, but making this option easily available and attractive (via a much higher replacement rate) will help both workers and businesses.

Another avenue for employers to keep their workers on payroll is through work-sharing. For many employers considering cutting back on employment due to social distancing measures, work sharing measures can help keep workers working but for less hours, with the government paying for much of the lost hours. Essentially, it’s the government paying workers to stay home because doing so is a public health benefit.

The best way to do this in our current environment is using the work-sharing provisions within the UI system. Here’s the basic idea. Imagine you’re a business owner and your employees can work remotely. However, because of lost demand, you can’t afford to keep all your workers on payroll full time and are considering reducing total work hours by 30. You could lay off 30% of your workers, or you could cut hours. An alternative is if the government steps in and says, lower your hours by 30% for your workers, don’t lay anyone off, and we will pick up (much of) the tab. That’s exactly what work sharing does. This option may also be attractive to businesses where workers can work remotely, but the slowdown in the economy has reduced revenues substantially.  Work-sharing has worked well in other countries, especially Germany during the last recession.[iii]  It’s no wonder that Germany has announced plans to use work sharing to deal with the COVID-19 crisis.

Currently, 27 states in the US have work-sharing provisions.  Under my plan, the federal government would require all states to offer it. Moreover, and equally importantly, it would provide and pay for much higher wage replacement for lost hours (perhaps around 90-95%). Why is this important? First, because it makes sure workers’ paychecks are being sufficiently secured. It’s also costly for incumbent workers (who would not have lost a job) to see a pay cut. Employers want to minimize that pay cut as much as possible, as pay reductions to incumbent workers can reduce morale and lead best workers to leave. Indeed, too much of a wage reduction for incumbent workers would likely lead employers to not participate in rent sharing. In addition, the somewhat higher replacement rate provides an incentive to employers to use work sharing over temporary layoffs.  The rationale for that is we want to incentivize employers to keep workers not only on their payroll but economically engaged if it meets economic and health objectives (e.g., remote work). This can help facilitate the recovery after social distancing ends by preventing depreciation of firm-specific skills.

Some employers may not participate in work sharing and may cut workers’ hours. To protect workers against this, and to help workers stick around at their jobs, we can boost the partial UI benefits. This program allows workers with an involuntary reduction in. hours to receive partial benefits. However, as it is structured, a worker who saw her hours cut by 50% would receive little or no benefits in most cases. But we can easily modify this to ensure that those workers seeing reduction in hours can keep much of their earnings intact.

Federal funding

The final part of this is funding. In normal times, UI is funded using employer payroll taxes, and using “experience rating” which means those employers whose workers end up using UI more see hike in what they pay.  However, in times of economic crises, the federal government usually steps in.

Under my proposal, the federal government would re-start the Emergency Unemployment Compensation (EUC) system, the key vehicle it used during the Great Recession to fund the dramatic increase in UI maximum benefit duration to as much as 99 weeks during that period.

In particular, all additional UI expenditures should be borne by the federal government, which is uniquely advantaged in doing so. Moreover, it’s important that businesses accessing these emergency UI provisions are not penalized through increased experience rating; so there would be a experience rating holiday until the crisis passes. (Experience rating means that in normal times, businesses with a lot of workers using UI have to pay more in taxes; right now we do not want to do that.)

At the end of the day, we need a way for the federal government to pay workers to stay at home and get a paycheck. First and foremost, this helps our public health objectives of keeping non-essential workers home and reduce the risk of transmission. Second, it helps workers most at need. Third, it not only helps workers, but also helps reduce the burden on employers. By removing a large part of the costs facing an employer to the public sector, it can make the difference when it comes to an employer deciding to shut down or not. The federal government can help by temporarily picking up the tab when it comes to the paycheck.

The size of this program will depend critically on the size of the downturn and the exact parameters we choose—replacement rates, benefit caps, and so on. Assuming an average replacement rate of 85 percent, and a maximum weekly benefit cap of $1500, I estimate that the average UI-eligible earnings of workers would be around $910, and that their weekly benefit amount would be around $773. To put this in perspective, the current average weekly UI benefit is around $350, so this would likely more than double the take home pay for those on UI.^[iv] What would this UI expansion cost? Consider a hypothetical scenario where the unemployment rate is sharply elevated to around 20 percent for around six months and assume that with more comprehensive coverage, 75 percent of the unemployed receive benefits. The combination of comprehensiveness and generosity will mean that expenses grow by roughly $365 billion. The higher replacement rate and higher eligibility both make important contributions to this increase.

Of course, there are many unknowns about the depth and duration of this downturn. But the key point is that if the size of the hole is bigger than we thought, we should want to spend more to plug it. And UI spending is extremely well targeted for both social insurance and aggregate demand purposes.

What’s not here?

To be clear, this is not the only piece of fiscal policy we need to enact.  We will need additional provisions to help employers (like no-interest loans proposed by Ozimek and Lettieri[v] or subsidies for rent and other non-labor costs), especially in hard hit sectors. We will need to strengthen the safety net for low income families, especially through SNAP. The federal government will also need to help support state and local governments’ finances to avoid reduction in spending and employment that can prolong the downturn.

And finally, we need to plan for a big consumption increase once the social distancing is removed to help supercharge a recovery. As the figure below suggests, we want to move from social insurance to stimulus over time.

Figure 1 What the ideal balance of fiscal policy should look like

This means there is definitely a scope for general stimulus policies (like a check for several thousand dollars to each family as pushed for by proponents from both sides of the isle). This will set us up for a faster recovery once we are in that phase (and it may take some time for those checks to arrive).  But it is critical that we deal with the balance sheets of households and businesses who are most severely hit by the current crisis.

Endnotes

[i] Saez, Emmanuel and Gabriel Zucman. 2020. “Keeping Business Alive: The Government as Buyer of Last Resort” EconFip Policy brief # 20.

[ii] Hubbard, Glen and Micahel Strain. 2020. “A Business Fiscal Response to the Covid-19 Recession” AEI Report.

[iii] Hassett, Kevin and Michael Stang. 2014. “Worksharing and long-term unemployment” AEI Report.

[iv] https://www.usatoday.com/story/money/2019/06/02/best-and-worst-states-to-be-unemployed/39526585/

[v] https://eig.org/news/main-street-rescue-and-resiliency-program

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1. Scale down economic activity in a rapid way to keep people at home, but without devastating the physical, cultural, or organizational capital that will be needed to restore growth and normality.
2. Boost the confidence of markets — both retail and financial markets — by showing progress in limiting the spread of the disease. (But note that merely slowing the spread of the disease may not help the economy, as uncertainty would linger for longer periods of time.)
3. Keep business in a position to rebound.
4. Create incentives for production to bounce back once that is appropriate.

You will notice a tension between #1 and #2-4, which is what makes this policy issue so difficult. The ideal policy mix should both lower and raise output, and at just the right speed. No one ever taught us how to do that.

Furthermore, policymakers need to figure out which sectors a) we wish to keep up and running (food, health care), b) which sectors we want to contract rapidly but bounce back rapidly as well (education), and c) which sectors we do not want to protect at all and would be willing to see perish (e.g., cruise ships, note that most operate under foreign flags and employ mainly non-Americans).

Those classes of sector may require very different economic policies, most of all we should not waste aid on the latter class of sectors. Be nervous of general proposals for “the economy.”

Most of the ideas that follow are designed to bring a contraction followed by a very elastic rebound. As to exactly when that rebound should come, that is a question for public health and better data gathering will be needed to make that judgment. I do not consider that question in this document, though we do recognize its urgency. I also do not consider how to improve the micro-organization of hospitals and other health care institutions, see here.

Here are the best ideas we have seen, ruling out laws already enacted. I rank them in order of “most no brainer” to “most complicated.” In other words, the items toward the top of the list have simple, hard to contest arguments in their favor. It still may be the case, however, that the more complicated and possibly riskier items toward the bottom of the list have higher expected returns. We hope to start with consensus and see how far we can maintain such agreement.

Relax occupational licensing for medical professionals

Make it easier for nurses, doctors, and indeed all health care practitioners to work anywhere in the United States. Many states already have taken moves in this direction, transferring licenses within one day for out of state health care workers.

Labor supply

Bring back doctors and nurses from retirement if they are willing, and give them accelerated approval to work in any state. Accelerate degree completion for medical aides in their last phases of study, as has been done in Italy. Basically give those individuals the degree now so they may get to work. Find other ways of allowing current medical students to contribute to the effort.

Limit the costs of the trade war

Remove all recent tariffs on goods and services placed on China and Europe, and abolish all tariffs and trade restrictions on medical equipment. Freer trade will generate more revenue for American businesses and help keep jobs in place. And what if it is China that first develops a usable vaccine or other cure? We do not want to be in a trade war with them under those circumstances. The American government should not stop its campaign to keep hostile foreign companies out of our communications systems, however.

Prizes

The Federal government should create prizes for medical breakthroughs related to the coronavirus. This could include a prize for the production of rapidly scalable ventilator and oxygen delivery technologies (effective for patients experiencing ARDS), a prize for a working vaccine, and a prize for finding off-label cures or partial cures. Foreign nationals should be eligible for these prizes, which could be run out of the NIH, the NSF, and ARPA.

Unemployment insurance

“In states experiencing severe outbreaks, Congress should waive the requirement that people receiving unemployment insurance payments look for work. Better that such unemployed workers receive financial assistance for rent, mortgages and groceries than to risk spreading the virus by applying and interviewing for jobs. Congress should also waive work requirements in the food-stamp program.” Link here.

Also make it easier for individuals to get unemployment insurance temporarily if they are laid off temporarily but still tied to their firms. Eligibility should be eased, filing periods eliminated, and speed accelerated, and at the expense of the federal government not the states.

Protect returns on innovation investments

The Federal government should promise to protect the patents and copyrights of major innovators in this area. That said, the government should (if necessary) stand ready to buy those rights at auction and then distribute the cures or palliative measures at relatively low cost. For instance, the federal government may wish to buy up the patent rights for potentially scalable ventilators and release them into the public domain, thus ensuring a lower price for the product. If those same patent rights are confiscated, the incentives for future innovation will be lower. That is especially problematic if this crisis lasts for some period of time.

Let the economy gear up again

Lift restrictions on hours, overtime, and working on weekends. When the time for recovery comes, employers may wish to ask for more hours from able workers to accelerate recovery and rebuilding. This may be especially important for running public infrastructure such as subways. Be prepared to open public schools over the summer or other closed times, if need be, to help parents get back to work. It does not matter if the teachers simply are acting as de facto babysitters.

Keeping people at home

Voluntary clearinghouses, at state and local levels, should be set up to help allocate the labors of Americans wishing to volunteer. How about one-on-one volunteer tutors on Skype? In addition to filling in educational gaps, this would help keep Americans at home and boost their morale. A verbal nudge to the non-profit sector could go a long way here.

The government also should raise the idea of entertainment companies offering temporary free streaming services, or various sporting events (e.g., the NBA playoffs) being held on a limited, quarantine basis, if only to keep television viewers at home and away from public spaces. Do not let such games be shown in crowded bars.

Cash payments in the hands of Americans

Send every American a $1,000 check asap. If nothing else, it will make it easier for sick individuals to stay at home. It also will help low-wealth individuals stock up on necessary supplies. The easiest and quickest ways to do this are to lower federal tax withholding, extend the deadline for tax payments, and also boost the value of food stamp and TANF allocations to help reach lower income groups.

Increase the federal matching rate for Medicaid

“Currently the federal government pays about 60 percent of the cost of Medicaid, over 70 percent of the cost of the Children’s Health Insurance Program, and 90 percent of the cost of the Medicaid expansion population, with the remaining costs paid by states.” (Link). Raise the federal share here, if only temporarily, and suspend work requirements for Medicaid, as those will be increasingly difficult for many people to meet.

Send direct federal aid to the states as well, noting that collapsing equity returns may mean that many state pension plans are insolvent over time. In the short run, states will be pressed to keep local infrastructure up and running, one problem of many being dealing with coronavirus in prisons.

Small business bankruptcy reform

Grant businesses a temporary moratorium on loan principal repayment, and extend due dates for trade finance bills. If need be, the moratorium can be extended, but with a potentially high penalty interest rate on repayments, to encourage businesses with cash to repay their debts promptly. The Fed, through its role as lender of last resort to banks, would in essence be picking up some of the potential liability here, should some banks come close to insolvency.

Consumer and homeowner loan forbearance

Give consumers greater default forbearance on their loans, including their home mortgages.

Bank capital forbearance

Arnold Kling wrote: “I believe that the best macroeconomic response to the virus crisis would be what I call forbearance. Bank regulators would tell banks that they will be allowed to fall below minimum capital requirements. They will be allowed to write down the value of loans without having to raise capital as a result. They will be encouraged to in turn offer forbearance to borrowers, provided that there is a reasonable prospect that borrowers will be able to get repayments back on track once the crisis has passed.”

Relax price gouging laws

Relax state and local laws against price gouging. Although the practice is unpopular, higher prices give suppliers an incentive to keep goods on the shelves. Higher prices also discourage panic buying and increase the chance that the people who truly need  particular goods and services have a greater chance of getting them. In any case, speculation should not be the law enforcement priority moving forward.

Payroll tax cut, for the employer side only, for small and medium-sized enterprises

Make it easier for liquidity-strapped small and medium-sized businesses to keep workers on the payroll.

Pay people to work at home and also self-quarantine

Push employers to reward employees for staying at home. Fiscal policy might enter as well: “Instead of paying people to dig and fill ditches we could pay people to help train machine-learning apps, enter data, subtitle videos. take surveys, maybe even fold proteins to disrupt viruses.” Another option is to pay younger people small sums of money — less than the minimum wage — to stay at home for extended periods of time.

Induce wage and/or hour reductions for damaged sectors

Government-recommended (but not mandated) nominal wage reductions of 5% in sectors that are likely to come back. This can take the form of pay cuts or hours reduction with work-sharing. For most jobs this amounts to the government offering a nudge/recommendation in favor of a German-like system of shared reductions in hours rather than terminations. The goal is to limit unemployment and stress, and also to maintain consumer spending.

It is understood that these proposals, in sum, will mean a much higher budget deficit and higher inflation rate, the latter at least temporarily. A separate discussion would be required to present the best possible fiscal and monetary policy responses.

The post Plans for Economic Mitigation from the Coronavirus appeared first on Economics for Inclusive Prosperity.